“I know headquarters wants us to add that new product line,” said Dell Havasi, m
ID: 2589126 • 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 $2,350,000. The cost and revenue characteristics of the new product line per year would be:
Required:
1. 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. (Round the "Margin", "Turnover" and "ROI" answers to 2 decimal places.)
2. If you were in Dell Havasi’s position, would you accept or reject the new product line?
3. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
4. Suppose that the company’s minimum required rate of return on operating assets is 15.00% and that performance is evaluated using residual income.
a. 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.
b. Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line?
Sales $ 21,810,000 Variable expenses 13,741,200 Contribution margin 8,068,800 Fixed expenses 6,040,000 Net operating income $ 2,028,800 Divisional operating assets $ 4,363,000Explanation / Answer
1) Statement Showing calculation of ROI (Amount in $)
WN 1 Operating Income from new line = [9,396,500 - (9,396,500*65%) - 2,564,875] = 723,900
2) If I am in Dell Havasi's position, I would reject the new product line because the overall ROI after adding new product line has declined from 46.50% to 41%.
3) Adding the new line would increase the company's overall ROI.
4) a) Calculation of Residual Income (Amount in $)
b) Under these circumstances, I would accept the project because residual income of the company has increased from $1,374,350 to $1,745,750 with the new product line
Particulars Present New Line Total 1) Sales 21,810,000 9,396,500 31,206,500 2) Net Operating Income 2,028,800 723,900 2,752,700 3) Operating Assets 4,363,000 2,350,000 6,713,000 4) Margin (2/1) 9.30% 7.70% 8.82% 5) Turnover (1/3) 5.00 4.00 4.65 6) ROI (4*5) 46.50% 30.80% 41.01%Related Questions
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