\"I know headquarters wants us to add that new product line,\" said Dell Havasi,
ID: 2578588 • 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 ROls. Operating results for the company's Office Products Division for the most recent year are given below: Sales $23,000,000 Variable expenses 14,365,000 Contribution margin 8,635,000 Fixed expenses Net operating income Divisional operating assets 6,220,000 $ 2,415,000 S 5,001,000 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 $2,501,000. The cost and revenue characteristics of the new product line per year would be: Sales Variable expenses Fixed expenses $10,100,000 65% of sales $2,644,900Explanation / Answer
Part 1 Income Statement Present New Line Total Sales $23,000,000 $10,100,000 $33,100,000 Variable expenses $14,365,000 $6,565,000 $20,930,000 Contribution margin $8,635,000 $3,535,000 $12,170,000 Fixed expenses $6,220,000 $2,644,900 $8,864,900 Net operating income $2,415,000 $890,100 $3,305,100 a) Present New Line Total Sales $23,000,000 $10,100,000 $33,100,000 Net operating income $2,415,000 $890,100 $3,305,100 Operating assets $5,001,000 $2,501,000 $7,502,000 Margin % = NOI/Sales 10.50% 8.81% 9.99% Asset Turnover = sales/operating assets 4.60 4.04 4.41 ROI = Margin% x Asset Turnover 48.29% 35.59% 44.06% 2) Dell Havasi will reject the new product line as it would reduce his division’s overall rate of return. 3) Adding the new line would Increase the company's overall ROI The new product line 's ROI is 35.59%, whereas the company’s overall ROI last year was only 16% 4) a) Present New Line Total Operating assets $5,001,000 $2,501,000 $7,502,000 Minimum required return x 13% x 13% x 13% Minimum net operating income $650,130 $325,130 $975,260 Actual net operating income $2,415,000 $890,100 $3,305,100 Minimum net operating income (above) $650,130 $325,130 $975,260 Residual income $1,764,870 $564,970 $2,329,840 b) Dell Havasi will Accept the new product line as it would increase the total amount of his division’s residual income.
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