\"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 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 the most recent year are given below: $ 22,045,000 Sales Variable expenses 13,882,000 Contribution margin Fixed expenses 8,163,000 6,070,000 $ 2,093,000 $ 5,500,000 Net operating income Divisional operating asset 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 $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 $2,574,100

Explanation / Answer

Required 1

750900

(9500000-(65%*9500000)-2574100)

9.49%

(2093000/22045000)

7.90%

(750900/9500000)

9.02%

(2843900/31545000)

4.01

(22045000/5500000)

3.80

(9500000/2501500)

3.94

(31545000/8001500)

38.05%

(9.49%*4.01)

30.02%

(7.90%*3.80)

35.54%

(9.02%*3.94)

Required 2

Reject. Dell Havasi will be inclined to reject the new product line because accepting it would reduce his division’s overall rate of return.

Required 3

Adding the new line would increase the company's overall ROI.

The new product line promises an ROI of 30.02%, whereas the company’s overall ROI last year was only 16.00%. Thus, adding the new line would increase the company’s overall ROI.

Regarding 4

272090

(2093000*13%)

97617

(750900*13%)

369707

(2843900*13%)

Required 4 b

Accept. Under the residual income approach, Dell Havasi would be inclined to accept the new product line because adding the product line would increase the total amount of his division’s residual income, as shown above.

Present new line total Sales 22045000 9500000 31545000 Net operating income 2093000

750900

(9500000-(65%*9500000)-2574100)

2843900 Operating assets 5500000 2501500 8001500 Margin

9.49%

(2093000/22045000)

7.90%

(750900/9500000)

9.02%

(2843900/31545000)

Turnover

4.01

(22045000/5500000)

3.80

(9500000/2501500)

3.94

(31545000/8001500)

ROI

38.05%

(9.49%*4.01)

30.02%

(7.90%*3.80)

35.54%

(9.02%*3.94)

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