? know headquarters wants us to add that new product line.\" said Dell Havas, ma

Question

? know headquarters wants us to add that new product line." said Dell Havas, manager of Billings Company's Office Products Division "ButI want to see the numbers before l 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 this year are given below: Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets $ 21,750,000 13,731,600 8,018,400 6,025,000 1,993,400 $ 4,338,800 The company had an overall return on investment (ROI) of 18.00% this year (considering all divisions). Next year the Office Products Division has an opportunity to add a new product line that would require an additional investment that would increase average operating assets by $2,126,350. The cost and revenue characteristics of the new product line per year would be Sales Variable expenses Fixed expenses $9,350,000 65% of sales $2,560,500 Requirec 1. Compute the Office Products Division's ROI for this year 2. Compute the Office Products Division's ROI for the new product line by itself. 3. Compute the Office Products Division's ROI for next year assuming that it performs the same as this year and adds the new product line 4. If you were in Dell Havasi's position, would you accept or reject the new product line? 5. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line? 6. Suppose that the company's minimum required rate of return on operating assets is 14% and that performance is evaluated using residual income a. Compute the Office Products Division's residual income for this year b. Compute the Office Products Division's residual income for the new product line by itself c. Compute the Office Products Division's residual income for next year assuming that it performs the same as this year and adds the new product line d. Using the residual income approach, if you were in Dell Havasis position, would you accept or reject the new product line?

Explanation / Answer

1)ROI this year =net operating income /average operating asset

         = 1993400/4338800

         = .4594 or 45.94%

2)Net operating income of new product : [sales *(1-Variable cost )]-fixed cost

      =[9350000*(1-.65)]-2560500

       = 3272500-2560500

         = 712000

ROI =712000/2126350

= .3348 or 33.485

3)Total operating income = 1993400+712000=2705400

average operating asset =4338800+2126350 =6465150

ROI = 2705400 / 6465150

      = .4185 or 41.85%

4)Since with introduction of new product line ,the ROI of office product division has decreased from 45.94% to 41.85% ,New line should not be introduced.

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