“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2579764 • 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:
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 $2,262,500. The cost and revenue characteristics of the new product line per year would be:
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. (Do not round intermediate calculations. Round your Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)
If you were in Dell Havasi’s position, would you accept or reject the new product line?
Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
Suppose that the company’s minimum required rate of return on operating assets is 16.00% and that performance is evaluated using residual income.
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. (Enter your Minimum Required Rate as a whole percentage (i.e., 0.12 should be entered as 12).)
“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.”
Explanation / Answer
1. Office Products division current ROI.
ROI of recent year = Net Operating income / Division operating assets
= 1,814,600 / 4,220,000 = 43%
ROI if new product line is added.
ROI of new product line:
Net operating income = Sales - Variable Cost - Fixed Cost
= 9,050,000 - (65% x 9,050,000) - 2,534,000 = $633,500
New product line assets = $2,262,500
ROI on new product line = 633,500 / 2,262,500 = 28%
Calculation of Overall ROI of Office Products division
Net Overall Operating Income = $1,814,600 + 633,500 = $2,448,100
Overall Division Assets = 4,220,000 + 2,262,500 = $6,482,500
Overall Division ROI = 2,448,100 / 6,482,500 = 37.76%
2. Proposal of adding new product would have been rejected as it leads to the decline of overall ROI from current 43% to 37.76%.
3. The headdquarters must be looking the project from overall company view and therefore, overall company ROI must have increased due to addition of new product line. Because of this reason, the headquarters is anxious to add new line.
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