“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2463835 • 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 $2,250,500. The cost and revenue characteristics of the new product line per year would be:
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.)
2. If you were in Dell Havasi’s position, would you accept or reject the new product line?
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.
Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line?
“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.”
Explanation / Answer
Answer 1
Most recent year
Additional product
Total
Sales (3)
21902000
9450000
31352000
Variable expenses
13788600
6142500
19931100
Contribution margin
8113400
3307500
11420900
Fixed expenses
6055000
2570200
8625200
Net operating income (1)
2058400
737300
2795700
Divisional operating assets (2)
4562500
2250500
6813000
Margin % (1)/(3)
9.40%
7.80%
8.92%
Asset Turnover
4.80
4.20
4.60
ROI (1)/(2)
45.12%
32.76%
41.03%
Answer 2
Reject. Since overall ROI of office product division will decrease
Answer 3
Adding the new line would Decrease the company's overall ROI.
Answer 4 A
Divisional operating assets (2)
4562500
2250500
6813000
Required minimum ROI
14%
14%
14%
Minimum operating income
638750
315070
953820
Actual net operating income
2058400
737300
2795700
Residual income
1419650
422230
1841880
Answer 4 B
Accept. Since performance is evaluated on the basis of residual income and on adding new product residual income is increasing
Most recent year
Additional product
Total
Sales (3)
21902000
9450000
31352000
Variable expenses
13788600
6142500
19931100
Contribution margin
8113400
3307500
11420900
Fixed expenses
6055000
2570200
8625200
Net operating income (1)
2058400
737300
2795700
Divisional operating assets (2)
4562500
2250500
6813000
Margin % (1)/(3)
9.40%
7.80%
8.92%
Asset Turnover
4.80
4.20
4.60
ROI (1)/(2)
45.12%
32.76%
41.03%
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