“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2456202 • 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 $ 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 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 your Turnover answers to 1 decimal place. Round your Margin and ROI percentage answers to 1 decimal place (i.e., 0.123 should be entered as 12.3).)
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. 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 12% and that performance is evaluated using residual income.
present new line total
operating assets
minimum required return % % %
minimum net operating income
actual net operationg income
minimum net operation income
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. (Enter your Minimum Required Rate as a whole percentage (i.e., 0.12 should be entered as 12).)
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
Sales $2,000,000 Variable expenses 60% of sales (2,000,000*60/100) 1,200,000 Contribution margin 800,000 Fixed expenses 640,000 Net operating income 160,000 Return on Investment(ROI) Margin x Turnover Margin= Net operating income/sales Margin= 160,000/2,000,000 Margin= 0.08 Operating assets= 1,000,000 Turnover= Sales/Average operating assets Average operating assets= 4,000,000+1,000,000/2 Average operating assets= 5,000,000/2 Average operating assets= 2,500,000 Turnover= Sales/Average operating assets Turnover=2,000,000/2,500,000=0.8 ROI= Margin x Turnover ROI= 0.08 x 0.8 0.064
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