Question

In: Accounting

“I know headquarters wants us to add that new product line,” said Dell Havasi, manager of...

“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:

Sales $ 21,100,000
Variable expenses 13,350,400
Contribution margin 7,749,600
Fixed expenses 5,935,000
Net operating income $ 1,814,600
Divisional average operating assets $ 4,220,000

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 $2,262,500. The cost and revenue characteristics of the new product line per year would be:

Sales $9,050,000
Variable expenses 65% of sales
Fixed expenses $2,534,000

Required

6. Suppose that the company’s minimum required rate of return on operating assets is 16% 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 Havasi’s position, would you accept or reject the new product line?

Solutions

Expert Solution

income on new line
contribution (9,050,000*35%)= 3,167,500
less Fixed expense -2,534,000
Net operating income 633500
1,2&3) present new line total
Sales 21,100,000 9,050,000 30,150,000
Net operating income 1,814,600 633,500 2,448,100
operating assets 4,220,000 2,262,500 6,482,500
margin 8.60% 7.00% 8.12%
turnover 5.00 4.00 4.65
ROI 43.00% 28.00% 37.76%
where margin = net operating income/sales
turnover = sale/average operating assets
ROI = margin *turnover
4) Reject
5) Addint the new product line would improve overall ROI
6) Residual income = net operating income -(average assets *min rate or return)
present new line total
operating assets 4,220,000 2,262,500 6,482,500
minimum required return 16% 16% 16%
min net opeerating income 675200 362000 1037200
actual net operating income 1,814,600 633,500 2,448,100
min net operating income 675200 362000 1037200
residual income 1,139,400 271,500 1,410,900
b) Accept

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I know headquarters wants us to add that new product line,” said Dell Havasi, manager of...
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...
“I know headquarters wants us to add that new product line,” said Dell Havasi, manager of...
“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...
“I know headquarters wants us to add that new product line,” said Dell Havasi, manager of...
“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...
“I know headquarters wants us to add that new product line,” said Dell Havasi, manager of...
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