\"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 $20,800,000
Variable expenses 13,198,400

Contribution margin 7,601,600
Fixed expenses 5,833,600

Net operating income $1,768,000

Divisional operating assets $5,200,000


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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 $3,400,000. The cost and revenue characteristics of the new product line per year would be:



Sales $9,860,000
Variable expenses 60% of sales
Fixed expenses $3,273,520

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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 interim calculations and final answers to 2 decimal places. Omit the "%" sign in your response.)


ROI
Present %
New Line %
Total for company %

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

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

(Click to select)Adding the new line would increase the company's overall ROI.Adding the new line would decrease the company's overall ROI.
Requirement 4:
Suppose that the company's minimum required rate of return on operating assets is 15% 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 $

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


(Click to select)AcceptReject

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Worksheet Learning Objective: 10-2
Difficulty: Basic Learning Objective: 10-3

Explanation / Answer

Requirement 1. Last year's ROI = Net income / total divisonal assets that is as fpllows Most recent year sales 23780000 Variable cost 15107090 contribution 8672910 fixed cost 6651610 Net operating Income 2021300 Divisional operating assets 5800000 ROI 0.3485 34.85% Most recent year sales 23780000 Variable cost 15107090 contribution 8672910 fixed cost 6651610 Net operating Income 2021300 Divisional operating assets 5800000 ROI 0.3485 34.85%
if new product line added ,then ... Most recent if new Mixed year product sales 23780000 7840000 31620000 Variable cost 15107090 4704000 19811090 contribution 8672910 3136000 11808910 fixed cost 6651610 2602880 9254490 Net operating Income 2021300 533120 2554420 0 Divisional operating assets 5800000 2800000 8600000 ROI 0.3485 0.1904 0.297026 34.85% 19.04% 29.70% 2.Requirement: I will accept this one ,becuse her cost of capital is 15% is less than the RoI 19.04% Requirement 3: Adding the new product line would decrease the over all ROI but increase the profit. Requirement 4: If companies Minmum required rate of return is 16% the n resedual income would be : Requirement 5 : a) Most recent if new Mixed year product sales 23780000 7840000 31620000 Variable cost 15107090 4704000 19811090 contribution 8672910 3136000 11808910 fixed cost 6651610 2602880 9254490 Net operating Income 2021300 533120 2554420 0 Divisional operating assets 5800000 2800000 8600000 ROI 0.3485 0.1904 0.297026 34.85% 19.04% 29.70% Cost of capital 16% 928000 448000 1376000 Resedual income 1093300 85120 1178420 b) I will accept the new product , because it has resedual value of $85120. Thank you.. Most recent year sales 23780000 Variable cost 15107090 contribution 8672910 fixed cost 6651610 Net operating Income 2021300 Divisional operating assets 5800000 ROI 0.3485 34.85%

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