“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2468670 • 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 $ 22,600,000
Variable expenses 14,157,400
Contribution margin 8,442,600
Fixed expenses 6,160,000
Net operating income $ 2,282,600
Divisional operating assets $ 4,520,000
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 $2,450,000. 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 $ 2,595,000
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 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?
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 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.
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
Solution:
1)
2) Dell Havasi will be inclined to reject the new product line, since accepting it would reduce his division’s overall rate of return.
3) The new product line promises an ROI of 32.52%, whereas the company’s overall ROI last year was only 16%. Thus, adding the new line would increase the company's overall ROI.
4) a)
4) b) Under the residual income approach, Dell Havasi would be included to accept the new product line, since adding the product line would increase the total amount of his division's residual income, as shown above.
Present New Line Total 1 Sales 22,600,000 9,800,000 32,400,000 2 Operating income 2,282,600 835,000 3,117,600 3 Operating assets 4,520,000 2,450,000 6,970,000 4 Margin (2)/(1) 10.10% 8.52% 9.62% 5 Turnover (1)/(3) 5.00 4.00 4.65 6 ROI (4)*(5) 50.10% 32.52% 44.71%Related Questions
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