\"I know headquarters wants us to add that new product line,\" said Dell Havasi,
ID: 2538960 • 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 ROi, with year-end bonuses given to the divisional managers who have the highest ROls. Operating results for the company's Office Products Division for this year are given below: 0 Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets $ 22,600,000 14,157,400 8,442,600 6,160,000 $ 2,282,600 $ 4,520,000 The company had an overall return on investment ROI of 16.00% this year considering all divisions). Next year the Ofice Pro ctsDivs on has a opportunity to add a new product line that would require an additional investment that would increase average operating assets by $2,450,000. The cost and revenue characteristics of the new product line per year would be Sales Variable expenses Fixed expenses $9,800,000 65% of sales $2,595,000 1. Compute the Office Products Division's ROI for this year. 8 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?Explanation / Answer
*Net operating income = Sales - Variable Expenses- Fixed Expenses
1. ROI for this year: 50%
2. ROI for the new product line by itself: 34.08%
3. ROI for next year: 44.73%
4. Reject. Since accepting the new product line would reduce his division's overall rate of return.
6.
Under the residual income approach, Dell Havasi would be inclined to accept the new product line because adding the product line would increase the total amount of his division’s residual income, as shown above.
S.no. Particulars Present New Line Total 1. Sales 22600000 9800000 32400000 2 Net Operating Income 2282600 835000* 3117600 3 Operating Assets 4520000 2450000 6970000 4 Margin (2/1) 10.1% 8.52% 9.62% 5 Turnover (1/3) 5 times 4 times 4.65 times 6 ROI (4x5) 50% 34.08% 44.73%Related Questions
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