“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2405114 • 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 this year are given below:
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 $3,938,000. The cost and revenue characteristics of the new product line per year would be:
Required:
1. Compute the Office Products Division’s ROI for this year.
2. Compute the Office Products Division’s ROI for the new product line by itself.
3. Compute the Office Products Division’s ROI for next year assuming that it performs the same as this year and adds the new product line.
4. If you were in Dell Havasi’s position, would you accept or reject the new product line?
5. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
6. Suppose that the company’s minimum required rate of return on operating assets is 13% and that performance is evaluated using residual income.
a. Compute the Office Products Division’s residual income for this year.
b. Compute the Office Products Division’s residual income for the new product line by itself.
c. Compute the Office Products Division’s residual income for next year assuming that it performs the same as this year and adds the new product line.
d. Using the residual income approach, if you were in Dell Havasi’s position, would you accept or reject the new product line?
Sales $ 22,700,000 Variable expenses 14,363,700 Contribution margin 8,336,300 Fixed expenses 6,175,000 Net operating income $ 2,161,300 Divisional average operating assets $ 5,675,000Explanation / Answer
Answer to 1
Office products division's ROI for this year
= Net operating income/ Average operating assets
= $ (2161300/ 5675000)
= 38.08%
Answer to 2
Office products division's ROI for the new product line
Answer to 3
Office products division's ROI
Therefore, ROI is 31.30%
Answer to 4
If I were in the position of Dell Havasi's, I would not add the new product line, as overall divisional ROI has declined from 38.08% to 31.30%; which would impact year end bonuses payment.
Particulars Amount ($) Remarks Sales 9800000 Variable expenses 6370000 65% of sales i.e. (65% X 9800000) Contribution margin 3430000 Sales - Variable expenses Fixed expenses 2582900 Net operating income 847100 Contribution margin - Fixed expenses Average operating assets 3938000 Return on Investment (ROI) 21.51% Net operating income/ Average operating assetsRelated Questions
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