\"I know headquarters wants us to add that new product line. said Dell Havasi, m
ID: 2564899 • 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 ROl, 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 Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets s 21,982,886 13.788.68e 8,113,4ee 2,058.400 S 4,562,580 The company had an overall return on investment (ROI) of 18.00% 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 $2250,500. The cost and revenue characteristics of the new product line per year would be: Sales Variable expenses Fixed expenses $9,450,800 65% of sales $2,570,280 Requlred: 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 ROl 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 14% 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 d. Using the residual income approach, if you were in Dell Havasi's position, would you accept or reject the new product line? Complete this question by entering your answers in the tabs below. Req 1 to3 Req 4 Req 5 Req 6A to 6C Req 6DExplanation / Answer
Answer:
1
Present
Sales (1)
21902000
Net operating income (2)
2058400
Operating Assets (3)
4562500
Margin (2/1)
9.40%
Turnover(1/3)
4.800438
ROI=
(Margin turnover)
45.12%
_________________________________________________
2
For calculating the ROI of new line we need to calculate the net operating income of the New line
calculation of the net operating income of the New line
Sales
9,450,000
Less: variable cost
(9450,000*65%)
6142500
Less: Contribution margin
3,307,500
Fixed expenses
2,570,200
Net operating income
737,300
New
Line
Sales (1)
9,450,000
Net operating income (2)
737,300
Operating Assets (3)
2250500
Margin (2/1)
7.80%
Turnover(1/3)
4.199067
ROI=
(Margin turnover)
32.76%
____________________________________________________________
3
Calculation of the Office Products Division's ROI for the next year
Present
New
Line
Total
Sales (1)
21902000
9,450,000
31,352,000
Net operating income (2)
2058400
737,300
2,795,700
Operating Assets (3)
4562500
2250500
6,813,000
Margin (2/1)
9.40%
7.80%
8.92%
Turnover(1/3)
4.800438
4.199067
4.6017907
ROI=
(Margin turnover)
45.12%
32.76%
41.03%
____________________________________________________________
4
Answer: Reject the new Line
Explanation:
The new product line should be rejected as accepting new product line will decline the division overall rate of return (ROI) from 450.12% to 41.03%
_______________________________________________________________
5
Company will add the new product line because overall ROI is 18% where as new product line promise to give ROI of 32.76% thus adding of new line will increase the overall ROI of the company
_______________________________________________________________
6-a
Present
Operating Assets
4562500
Multiplied by
x
Minimum Return Required
14%
Minimum operating income
638750
Actual operating income
2058400
Residual Income
=(Actual operating income-Minimum operating income )
1419650
_______________________________________________
6-b)
New
Line
Operating Assets
2250500
Multiplied by
x
Minimum Return Required
14%
Minimum operating income
315070
Actual operating income
737300
Residual Income
=(Actual operating income-Minimum operating income )
422230
_______________________________________________
6-c
Present
New
Line
Total
Operating Assets
4562500
2250500
6813000
Multiplied by
x
x
x
Minimum Return Required
14%
14%
14%
Minimum operating income
638750
315070
953820
Actual operating income
2058400
737300
2795700
Residual Income
=(Actual operating income-Minimum operating income )
1419650
422230
1841880
_______________________________________________
6-D
Here Dell Hevansi will accept the new line because accepting new line will increase the Overall Divisional residual income
Present
Sales (1)
21902000
Net operating income (2)
2058400
Operating Assets (3)
4562500
Margin (2/1)
9.40%
Turnover(1/3)
4.800438
ROI=
(Margin turnover)
45.12%
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