“I know headquarters wants us to add that new product line,\" said Dell Havasi,
ID: 2341549 • 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 (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 ROl, 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 22,045,000 13,882,000 8,163,000 6,070,000 2,093,000 $ 5,500,000 The company had an overall return on investment (ROI) of 16.00% 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 $2,501,500. The cost and revenue characteristics of the new product line per year would be Sales Variable expenses Fixed expenses $9,500,000 65% of sales $2,574,100Explanation / Answer
Net operating income New product line = 9500000*(1-0.65)-2574100= $750900 ROI = Net operating income/Average operating assets 1 ROI for this year 38.05% =2093000/5500000 2 ROI for new product 30.02% =750900/2501500 3 ROI for next year 35.54% =(2093000+750900)/(5500000+2501500) 4. Reject, as Division's ROI decreases 5 Adding the new product line would increase company's overall ROI 6 Residual income for this year 1378000 =2093000-(5500000*13%) Residual income for new product 425705 =750900-(2501500*13%) Residual income for next year 1803705 =1378000+425705
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