“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2425416 • 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 $ 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 operating assets $ 5,675,000
The company had an overall return on investment (ROI) of 16.00% 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 $3,938,000. The cost and revenue characteristics of the new product line per year would be:
Sales $ 9,800,000
Variable expenses 65% of sales
Fixed expenses $ 2,582,900
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.? or
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 13.00% 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
Explanation / Answer
1. ROI for the most current year = Net operating income / Divisional operating assets = 2,161,300 / 5,675,000 x 100 = 38.08%
ROI if the new product line is added = ( 2,161,300 + 847,100) /( 5,675,000 + 3,938,000) = 3,008,400 / 9,613,000 x 100 = 31.30%
2. If I were in Dell Havasi's position, I would reject the new product line, as the divisional ROI decreases from 38% to 31%
3. Headquarters is anxious to add the new product line for improving overall ROI which is currently languishing at 16%.
4. a. Computation of residual income
b. If I were in Dell Havasi's position, I would accept the new product line as residual income increases from $ 1,423,550 to $ 1,758,710.
Present New Line Total Operating assets 5,675,000 3,938,000 9,613,000 Minimum rate of return 13% 13% 13% Minimum net operating income 737,750 511,940 1,249,690 Actual net operating income 2,161,300 847,100 3,008,400 Residual income 1,423,550 335,160 1,758,710Related Questions
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