“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2761830 • 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:
Sales
$
21,810,000
Variable expenses
13,741,200
Contribution margin
8,068,800
Fixed expenses
6,040,000
Net operating income
$
2,028,800
Divisional operating assets
$
4,363,000
The company had an overall return on investment (ROI) of 18.00% 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 $2,350,000. The cost and revenue characteristics of the new product line per year would be:
Sales
$ 9,396,500
Variable expenses
65% of sales
Fixed expenses
$ 2,564,875
Required:
1.
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.)
Present
New Line
Total
Sales
Net Operating Income
Operating Assets
Margin
%
%
%
Turnover
ROI
%
%
%
2.
If you were in Dell Havasi’s position, would you accept or reject the new product line?
Accept
Reject
3.
Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
Adding the new line would Increase the company's overall ROI.
Adding the new line would Decrease the company's overall ROI.
4.
Suppose that the company’s minimum required rate of return on operating assets is 15.00% and that performance is evaluated using residual income.
a.
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.
Present
New Line
Total
Operating Assets
Minimum required return
%
%
%
Minimum net operating income
Actual net operating income
Minimum net operating income
Residual Income
$
$
$
b.
Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line?
Accept
Reject
“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.”
Explanation / Answer
1. Office Products Division's ROI for the most recent year = Net operating income / Divisional operating assets x 100
= $ 2,028,800 / $ 4,363,000 x 100 = 46.5%
Office Products Division's ROI if the new product line is added = 2,752,700 / 6,713,000 x 100 = 41%
2. If I were in Dell Havasi's position, I would reject the new product line, as the ROI of the Office Products Division deteriorates after adding the new product line.
3. Headquarters is anxious to add the new product line so that the overall ROI of the company improves.
4. a . Computation of Residual Income for the Office Products Division:
b. Under these circumstances, I would accept the new product line, as the residual income increases on its addition.
Present New Line Total Operating Assets $ 4,363,000 $ 2,350,000 $ 6,713,000 Minimum required return 15% 15% 15% Actual net operating income $ 2,028,800 $ 723,900 $ 2,752,700 Minimum net operating income $ 654,450 $ 352,500 $ 1,006,950 Residual Income $ 1,374,350 $ 371,400 $ 1,745,750Related Questions
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