“I know headquarters wants us to add that new product line,” said Dell Havasi, m

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“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 (ROI) 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 ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the company’s Office Products Division for the most recent year are given below: Sales $ 21,500,000 Variable expenses 13,565,000 Contribution margin 7,935,000 Fixed expenses 5,995,000 Net operating income $ 1,940,000 Divisional operating assets $ 4,301,500 The company had an overall return on investment (ROI) of 17.00% 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 $2,313,700. The cost and revenue characteristics of the new product line per year would be: Sales $ 9,255,000 Variable expenses 65% of sales Fixed expenses $ 2,552,650 Required: 1. Compute the Office Products Division’s ROI for the most recent year; also compute the ROI as it would appear if the new product line is added. (Round the "Margin", "Turnover" and "ROI" answers to 2 decimal places.) 2. If you were in Dell Havasi’s position, would you accept or reject the new product line? Accept Reject 3. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line? Adding the new line would Increase the company's overall ROI. Adding the new line would Decrease the company's overall ROI. 4. Suppose that the company’s minimum required rate of return on operating assets is 14.00% and that performance is evaluated using residual income. a. Compute the Office Products Division’s residual income for the most recent year; also compute the residual income as it would appear if the new product line is added. b. Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line? Accept Reject

Explanation / Answer

Billing Company All Amounts in $ a. Working of Residual Income after adding New Product Line Existing New Product Total Scenario Line Operating Assets 4301500 2313700 6615200 Return on Investment 17% 14% 16% Minimum Operating Income 731255 323918 1055173 Actual Operating Income Sales 21500000 9255000 30755000 Variable Expenses 13565000 6015750 19580750 Fixed Expenses 5995000 2552650 8547650 Actual Operating Income 1940000 686600 2626600 Minimum Operating Income 731255 323918 1055173 Residual Income 1208745 362682 1571427 b. Under these circumstances, given the residual income values, the new product line should be accepted.

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