\"I know headquarters wants us to add on that new product line,\" said Dell Hava
ID: 2527083 • Letter: #
Question
"I know headquarters wants us to add on 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 has led the company for three years, and I don't want any letdown." Billings Company is a decentralized organization with five autonomous divisions. The divisions are evaluated on the basis of the return that they are able to generate on invested assets, with year-end bonuses given to the divisional managers who have the highest ROl figures. Operating results for the company's office products division for the most recent year are as follows Sales $504,000 ,000 Less: Variable expenses 327 ,600,000 Contribution margin 176,400,000 Less: Fixed expenses Net operating income Divisional operating assets 141,120,000 35,280000 84,000,000 The company had an overall ROI of 13.5% 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 $50,400,000. The cost and revenue characteristics of the new product line per year would be as follows $100,800,000 ales Variable expenses Fixed expenses 65% of sales 28,224,000Explanation / Answer
Part 1 Income Statement Present New Line Total Sales $504,000,000 $100,800,000 $604,800,000 Variable expenses $327,600,000 $65,520,000 $393,120,000 Contribution margin $176,400,000 $35,280,000 $211,680,000 Fixed expenses $141,120,000 $28,224,000 $169,344,000 Net operating income $35,280,000 $7,056,000 $42,336,000 a) Present New Line Total Sales $504,000,000 $100,800,000 $604,800,000 Net operating income $35,280,000 $7,056,000 $42,336,000 Operating assets $84,000,000 $50,400,000 $134,400,000 Margin % = NOI/Sales 7.00% 7.00% 7.00% Asset Turnover = sales/operating assets 6.00 2.00 4.50 ROI = Margin% x Asset Turnover 42.00% 14.00% 31.50% 2) Dell Havasi will reject the new product line as it would reduce his division’s overall rate of return. 3) 4) a) Present New Line Total Operating assets $84,000,000 $50,400,000 $134,400,000 Minimum required return x 13% x 13% x 13% Minimum net operating income $10,920,000 $6,552,000 $17,472,000 Actual net operating income $35,280,000 $7,056,000 $42,336,000 Minimum net operating income (above) $10,920,000 $6,552,000 $17,472,000 Residual income $24,360,000 $504,000 $24,864,000 b) Dell Havasi will Accept the new product line as it would increase the total amount of his division’s residual income.
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