“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2459839 • 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:
The company had an overall return on investment (ROI) of 18.00% 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 $2,126,350. The cost and revenue characteristics of the new product line per year would be:
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.)
2. If you were in Dell Havasi’s position, would you accept or reject the new product line?
Reject
3. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
4. Suppose that the company’s minimum required rate of return on operating assets is 14.00% 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.
b. Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line?
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:
Explanation / Answer
1. ROI for office products division:
ROI for a division is calculated as net operating income/ divisional assets = 1,993,400 / 4,338,800 x 100
= 45.94%
If the new product line is added, net operating income will be $ 2,705,400, and divisional assets will increase to
$ 6,465,150.
If the new product line is added, the overall ROI of the Office Products division will be,
2,705,400 / 6,465,150 x 100 = 41.85%
2. If I was in Dell Havasi's position, I would not be too keen to take on the new product line, as my divisions's ROI will fall from 45.94% to 41.85%. So answer is reject.
3. Adding the new line would increase the company's overall ROI.
4. a. Current Residual Income:
Residual Income = Operating Income - ( Cost of capital x Average operating assets)
= 1,993,400 - ( 0.14 x 4,338,800) = 1,385,968
Resiidual income if new product line is added will be 2,705,400 - (0.14 x 6,465,150 ) = $ 1,800,279
b. I would now accept the product line if I were in Dell Havasi's place.
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