know headquarters wants us to add that new product line,\" said Dell Havas, mana
ID: 2571915 • Letter: K
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know headquarters wants us to add that new product line," said Dell Havas, 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 Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets 21,100,000 13,350,400 7,749,600 5,935,000 1,814,600 $ 4, 220,000 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 $2,262,500. The cost and revenue characteristics of the new product line per year would be Sales Variable expenses Fixed expenses $9,050,000 65% of sales $2,534,000 Required: 1. Compute the Office Products Division's ROl 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 16% 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
Part 1, 2 ,3 Income Statement Present New Line Total Sales $21,100,000 $9,050,000 $30,150,000 Variable expenses $13,350,400 $5,882,500 $19,232,900 Contribution margin $7,749,600 $3,167,500 $10,917,100 Fixed expenses $5,935,000 $2,534,000 $8,469,000 Net operating income $1,814,600 $633,500 $2,448,100 a) Present New Line Total Sales $21,100,000 $9,050,000 $30,150,000 Net operating income $1,814,600 $633,500 $2,448,100 Operating assets $4,220,000 $2,262,500 $6,482,500 Margin % = NOI/Sales 8.60% 7.00% 8.12% Asset Turnover 5.00 4.00 4.65 ROI = Margin% x Asset Turnover 43.00% 28.00% 37.76% -1 -2 -3 4) Dell Havasi will reject the new product line as it would reduce his division’s overall rate of return. 5) Adding the new line would Increase the company's overall ROI The new product line 's ROI is 28%, whereas the company’s overall ROI last year was only 18% 6) a, b, c Present New Line Total Operating assets $4,220,000 $2,262,500 $6,482,500 Minimum required return x 16% x 16% x 16% Minimum net operating income $675,200 $362,000 $1,037,200 Actual net operating income $1,814,600 $633,500 $2,448,100 Minimum net operating income (above) $675,200 $362,000 $1,037,200 Residual income $1,139,400 $271,500 $1,410,900 d) 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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