\"I know headquarters wants us to add that new product line,\" said Dell Havasi,
ID: 2427586 • Letter: #
Question
"I know headquarters wants us to add that new product line," said Dell Havasi, manager of Billings Company's Office Products Division. "But I want to see the numbers before I make any move. Our division's return on investment (ROl) has led the company for three years, and I don't want any letdown. Billings Company is a decentralized wholesaler with five autonomous divisions. The divisions are evaluated on the basis of ROl, with year-end bonuses given to the divisional managers who have the highest ROls. Operating results for the company's Office Products Division for the most recent year are given below: Sales $ 21,810,000 Variable expenses 13,741,200 Contribution margin 8,068,800 Fixed expenses Net operating income Divisional operating assets 6,040,000 $ 2,028,800 $ 4,363,000 The company had an overall return on investment (ROI) of 18.00% last year (considering all divisions) The Office Products Division has an opportunity to add a new product line that would require an additional investment in operating assets of $2,350,000. The cost and revenue characteristics of the new product line per year would be Sales Variable expenses Fixed expenses $9,396,500 65% of sales $2,564,875Explanation / Answer
Return on Investment is a techique used to judge capital investment of a project. In this method company will calculate net operating profit. Then percentage of it on operating asset will be estimated. It is actual return on investment. There should be a minimum acceptable ROI. If actual ROI is more than acceptaable ROI, then project is accepted.
In this problem, company has overall ROI of 18% in the last year. It has a division, known as office product division. Its current relevant figures for ROI calculation are available. Further it has decided to add a new line. Its data are also available. Considering all this figures, decisios will be taken, about the acceptability of the project.
Step1: First calculate net operating income of new product line.
Step 2:
Now taking this new line into cosideration ROI figures are computed below:
The above table has been prepared on the basis of residual income. It is the excess of actual income over miimum required return. If it is positive, then the project will add something more than the miimum required return. It will make some value addition. So the project will be accepted.
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Here division has 31.5% ROI before adding this new line of activity. It is much higher than minimum required ROI 15% and company's overall ROI of 18%. However new line of product has ROI of only 15.8%. It is higher than miimum acceptable ROI, but below the overall ROI of the firm. As a rsult ROI of the division is dropped to 26%. Under this circumstances, divisional manager will refuse to add this line since performance and Bonus are calculated on the basis of ROI. However as it has ROI more than minimum required rate, some value addition is possile. Hence this line should be accepted unless some better option is found.
Details Amount 1. Sales $9,396,500 2. Variable cost [65% of sales] [$9,396,500x0.65] $6,107,725 3. Total contribution [1-2] $3,288,775 4. Fixed cost $2,564,875 5. Net operating Income [3-4] $723,900Related Questions
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