Chap 11 Problem “I know headquarters wants us to add that new product line,” sai
ID: 2594239 • Letter: C
Question
Chap 11 Problem
“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 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 $2,126,350. 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 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 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 $ 21,750,000 Variable expenses 13,731,600 Contribution margin 8,018,400 Fixed expenses 6,025,000 Net operating income $ 1,993,400 Divisional average operating assets $ 4,338,800Explanation / Answer
4.
I would reject the proposed product line, as it wil reduce the division's ROI by more than 4%.
5.
The headquarters may be anxious to intorudce the product line due to the fact that the ROI for the product line is way above the overall company's ROI of 18%.
6.
(d) Using the residual income, I wuld accept the new product line as it is adding $414,311 to the division's residual income.
1. Office Products Division's ROI = 45.94% Sales 21750000 Variable expenses 13731600 Contribution margin 8018400 Fixed expenses 6025000 Net operating income 1993400 Divisional average operating assets 4338800 ROI 45.94%Related Questions
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