\"I know headquarters wants us to add that new product line,\" said Dell Havasi,
ID: 2511239 • 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 (ROl) 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 ROls. Operating results for the company's Office Products Division for the most recent year are given below: Sales S 21,902,000 Variable expenses 13,788,600 Contribution margin 8,113,400 Fixed expenses Net operating income Divisional operating assets 6,055,000 S 2,058,400 $ 4,562,500 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 Sales Variable expenses Fixed expenses $9,450,000 65% of sales $2,570,200Explanation / Answer
Net Operating Income of New Line: G Sales $9,450,000 H=0.65*G Variable expenses $6,142,500 I=G-H Contribution margin $3,307,500 J Fixed Expenses $2,570,200 K=I-J Net Operating Income $737,300 1 Present New Line Total A Sales $21,902,000 $9,450,000 $31,352,000 B Net Operating Income $2,058,400 $737,300 $2,795,700 C Operating assets $4,562,500 $2,250,500 $6,813,000 D=B/A Margin 9.40% 7.80% 8.92% E=A/C Turnover 4.80 4.20 4.601790694 F=D*E ROI 45.12% 32.76% 41.03% 2 Yes ,the new product line should be accepted because its ROI is much higher than 18% Though it will reduce the ROI of the division from 45.12% to 41.03%, it is still much higher than 18% The new product line will increase the Net Present Value of the division 3 Headquarter is anxious to add new product line because Adding the new product line will increase the company's overall ROI 4 Computation of Residual Income Present New Line Total A Operating Assets $4,562,500 $2,250,500 $6,813,000 B Minimum required return 14% 14% 14% C=A*B Minimum net operating income $638,750 $315,070 $953,820 D Actual net operating income $2,058,400 $737,300 $2,795,700 C Minimum net operating income $638,750 $315,070 $953,820 E=D-C Residual Income $1,419,650 $422,230 $1,841,880 b Accept the new product line Because it gives positive residual income
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