“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2519952 • 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 this year are given below:
The company had an overall return on investment (ROI) of 17.00% 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 $2,326,200. The cost and revenue characteristics of the new product line per year would be:
6. Suppose that the company’s minimum required rate of return on operating assets is 14% and that performance is evaluated using residual income.
Sales $ 21,600,000 Variable expenses 13,622,600 Contribution margin 7,977,400 Fixed expenses 6,010,000 Net operating income $ 1,967,400 Divisional average operating assets $ 4,499,200Explanation / Answer
Net operating income new product line=9300000*(1-0.65)-2557400= $697600 1 ROI for this year 43.73% =1967400/4499200 ROI for the new product line by itself 29.99% =697600/2326200 ROI for next year 39.05% =(1967400+697600)/(4499200+2326200) 6 Residual income for this year 1337512 =1967400-(4499200*14%) Residual income for the new product line by itself 371932 =697600-(2326200*14%) Residual income for next year 1709444 =1337512+371932
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