\"I know headquarters wants us to add that new product line,\" said Dell Havasi,
ID: 2590393 • 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 ROls. Operating results for the company's Office Products Division for the most recent year are given below: Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional operating assets $ 21,600,000 13,622,600 7,977,400 6,010,000 $ 1,967,400 $ 4,499,200 The company had an overall return on investment (ROI) of 17.00% last year (considering all divisions). The Office Products Division has an opportunity to add a new product line that would require an additional investment in operating assets of $2,326,200. The cost and revenue characteristics of the new product line per year would be Sales Variable expenses Fixed expenses $ 9,300,000 65% of sales $2,557,400Explanation / Answer
Billiings Company
Office Product Division’s ROI
Present
New Line
Total
Sales
$21,600,000
$9,300,000
$30,900,000
Net Operating Income
$1,967,400
$697,600
$2,665,000
Operating Assets
$4,499,200
$2,326,200
$6,825,400
Margin
9.11%
7.50%
8.62%
Turnover
4.8 times
3.99 times
4.53 times
ROI
43.73%
29.93%
39.02%
Present
New Line
Total
Sales
$21,600,000
$9,300,000
$30,900,000
Variable Expenses
$13,622,600
$6,045,000
$19,667,600
Contribution margin
$7,977,400
$3,255,000
$11,232,400
Fixed expenses
$6,010,000
$2,557,400
$8,567,400
Net Operating Income
$1,967,400
$697,600
$2,665,000
Operating assets
$4,499,200
$2,326,200
$6,825,400
Calculation of residual income:
Present
New Line
Total
Operating Assets
$4,499,200
$2,326,200
$6,825,400
Minimum Required Return
14%
14%
14%
Minimum net operating income
$629,888
$325,668
$955,556
Actual net operating income
$1,967,400
$697,600
$2,665,000
Minimum net operating income
$629,888
$325,668
$955,556
Residual income
$1,337,512
$371,932
$1,709,444
Notes:
Margin = net operating income/sales
Present = (1,967,400/21,600,000) x 100 = 9.11%
Existing = (697,600/9,300,000) x100 = 7.5%
Total = (2,665,000/30,900,000) x 100 = 8.62%
Turnover = sales/operating assets
Present = 21,600,000/4,499,200 = 4.8 times
Existing = 9,300,000/2,326,600 = 3.99 times
Total = 30,900,000/6,825,400 = 4.53 times
ROI = margin x turnover
Present = 9.11% x 4.8 = 43.73%
Existing = 7.5% x 3.99 = 29.93%
Total = 8.62% x 4.53 = 39.02%
Present = 4,499,200 x 14% = $629,888
Existing = 2,326,200 x 14% = $325,668
Total = 6,825,400 x 14% = $955,556
Present = 1,967,400 – 629,888 = $1,337,512
Existing = 697,600 – 325,668 = $371,932
Total = 2,665,000 – 955,556 = $1,709,444
Office Product Division’s ROI
Present
New Line
Total
Sales
$21,600,000
$9,300,000
$30,900,000
Net Operating Income
$1,967,400
$697,600
$2,665,000
Operating Assets
$4,499,200
$2,326,200
$6,825,400
Margin
9.11%
7.50%
8.62%
Turnover
4.8 times
3.99 times
4.53 times
ROI
43.73%
29.93%
39.02%
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