“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2550190 • 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 17.00% 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 $2,484,500. 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 $ 22,900,000 Variable expenses 14,313,400 Contribution margin 8,586,600 Fixed expenses 6,205,000 Net operating income $ 2,381,600 Divisional average operating assets $ 4,580,000Explanation / Answer
1. ROI of Office Product Division:
ROI = Net Operating Income / Operating Assets X 100
= 2,381,600 / 45,80,000 X 100
= 52%
2. ROI for the new product line by itself:
3. ROI for next year assuming that it performs the same as this year and adds the new product line:
4. Being a Manager of a Company, i should reject the offer as by accepting offer ROI of Office Products Divisions is going to decrease.
5. The combined ROI of all divisions or company as a whole is 17% whereas the new product line offer ROI is 35.32% which almost double the ROI of the Company. Hence its look lucrative to Head office for accepting an offer.
6. Computation of Residual Income:
Existing Division (6a) (In $)
New Division (6b) (In $)
Total (6c)(In $)
(6d) If we use Rediaul Income approach, it is profitable for the comapny to add new Product line. we can see that by adding new product line company's residual income increase by $ 554,615.
Particulars Amount in $ Sales 9,942,400 Less: variable Expenses @ 65% 6,462,560 Contribution 3,479,840 Less: Fixed Cost 2,602,240 Net Operating Income 877,600 Operating Assets 2,484,500 ROI (877,600 / 2,484,500 X 100) 35.32%Related Questions
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