\"I know headquarters wants us to add that new product line,\" said Dell Havasi,

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 $10,000,000
Variable expenses

6,000,000
Contribution margin 4,000,000
Fixed expenses

3,200,000
Net operating income

$800,000
Divisional operating assets

$4,000,000



The company had an overall return on investment (ROI) of 15% 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 $1,000,000. The cost and revenue characteristics of the new product line per year would be:


Sales $2,000,000
Variable expenses 60% of sales
Fixed expenses $640,000

Requirement 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 your answers to 1 decimal place. Omit the "%" sign in your response.)

ROI
Present %?
New Line %?
Total for company %?

Requirement 2:
If you were in Dell Havasi's position, would you accept or reject the new product line?



Requirement 3:
Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?

Adding the new line would decrease/increase the company's overall ROI?


Requirement 4:
Suppose that the company's minimum required rate of return on operating assets is 12% 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. (Omit the "$" sign in your response.)

Residual
income
Present $ ?
New Line $ ?
Total for company $ ?

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

Accept/Reject

Explanation / Answer

1.ROI present = 800000/4000000 = 20% new line = 160000//net income of new line// increase in net income = 160000. increase in assets = 1000000 so ROI new line = 16% overall ROI = 800000+160000 /5000000 = 19.2% 2.reject..decrease in ROI from 20 to 19.5% 3.decrease 4. residual income present = 4000000*0.12 - 800000 = 320000 for new line = 1000000*0.12 - 160000 = 40000 total residual income = 5000000*0.12 - 960000 = 360000 yes i would accept as residual income has increased

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