“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2528477 • 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 (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 this year are given below:
The company had an overall return on investment (ROI) of 16.00% this year (considering all divisions). Next year the Office Products Division has an opportunity to add a new product line that would require an additional investment that would increase average operating assets by $2,875,000. The cost and revenue characteristics of the new product line per year would be:
Required:
1. Compute the Office Products Division’s ROI for this year.
2. Compute the Office Products Division’s ROI for the new product line by itself.
3. Compute the Office Products Division’s ROI for next year assuming that it performs the same as this year and adds the new product line.
4. If you were in Dell Havasi’s position, would you accept or reject the new product line?
5. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
6. Suppose that the company’s minimum required rate of return on operating assets is 13% and that performance is evaluated using residual income.
a. Compute the Office Products Division’s residual income for this year.
b. Compute the Office Products Division’s residual income for the new product line by itself.
c. Compute the Office Products Division’s residual income for next year assuming that it performs the same as this year and adds the new product line.
d. Using the residual income approach, if you were in Dell Havasi’s position, would you accept or reject the new product line?
Sales $ 21,400,000 Variable expenses 13,515,400 Contribution margin 7,884,600 Fixed expenses 5,980,000 Net operating income $ 1,904,600 Divisional average operating assets $ 5,350,000Explanation / Answer
income on new line contribution (9,200,000*35%)= 3,220,000 less Fixed expense -2,548,400 Net operating income 671600 1,2&3) present new line total Sales 21,400,000 9,200,000 30,600,000 Net operating income 1,904,600 671,600 2,576,200 operating assets 5,350,000 2,875,000 8,225,000 margin 8.90% 7.30% 8.42% turnover 4.00 3.20 3.72 ROI 35.60% 23.36% 31.32% where margin = net operating income/sales turnover = sale/average operating assets ROI = margin *turnover 4) Reject 5) Addint the new product line would improve overall ROI 6) Residual income = net operating income -(average assets *min rate or return) present new line total operating assets 5,350,000 2,875,000 8,225,000 minimum required return 13% 13% 13% min net opeerating income 695500 373750 1069250 actual net operating income 1,904,600 671,600 2,576,200 min net operating income 695500 373750 1069250 residual income 1,209,100 297,850 1,506,950 b) Accept
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