“I know headquarters wants us to add that new product line,” said Dell Havasi, m

ID: 2749102 • 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 the most recent year are given below:

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:

Compute the Office Products Division’s ROI for the most recent year; also compute the ROI as it would appear if the new product line is added. (Round the "Margin", "Turnover" and "ROI" answers to 2 decimal places.)

If you were in Dell Havasi’s position, would you accept or reject the new product line?

Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?

Suppose that the company’s minimum required rate of return on operating assets is 14.00% and that performance is evaluated using residual income.

Compute the Office Products Division’s residual income for the most recent year; also compute the residual income as it would appear if the new product line is added.

Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line?

Explanation / Answer

1)ROI for the recent year = Net operating income/Divisional Opearting Assets * 100

= 1,967,400/4,499,200 * 100

= 43.73%

Operating Income from nEw Product Line = 93,00,000*35% - 2,557,400

= 697,600

New operating Income after new product line is introduced = 1,967,400 + 697,600

= $26,65,000

New Divisional Operating Assets = 4,499,200 + 2,326,200

= $68,25,400

New ROI = 26,65,000/68,25,400 * 100

= 39.05%

2)ROI from new product line = 697,600/23,26,200 * 100

= 30%

Accept the new product line since RPI from new product is greater than 17%

3)Adding the new line would Decrease the company's overall ROI. (39.05% as compared to 43.73%)

4)a)Residual Income for most recent year if company’s minimum required rate of return on operating assets is 14.00% = 1,967,400 - 4,499,200*14%

= $1337,512

Residual Income after new product line is added if company’s minimum required rate of return on operating assets is 14.00% = 26,65,000 - 68,25,400*14%

= $1709,444

b)Accept the new product line

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“I know headquarters wants us to add that new product line,” said Dell Havasi, m

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“I know headquarters wants us to add that new product line,” said Dell Havasi, m

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