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: Sales $ 10,000,000 Variable expenses 6,000,000 Contribution margin 4,000,000 Fixed expenses 3,200,000 Net operating income $ 800,000 Divisional average operating assets $ 4,000,000 The company had an overall return on investment (ROI) of 15% 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 $1,000,000. The cost and revenue characteristics of the new product line per year would be: Sales $2,000,000 Variable expenses 60% of sales Fixed expenses $640,000

Required:

1. Compute the Office Products Division’s ROI for this year.

2. Compute the Office Products Division’s ROI for the new product line by itself.

3. Compute the Office Products Division’s ROI for next year assuming that it performs the same as this year and adds the new product line.

4. If you were in Dell Havasi’s position, would you accept or reject the new product line?

5. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?

6. Suppose that the company’s minimum required rate of return on operating assets is 12% 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?

These are all the parts to this one question. I really need help on how to solve this question. Thanks

Answer 1

	Present	New	Combine
Sales	$10,000,000	$2,000,000	$12,000,000
Less: variable expenses	$6,000,000	1200000	$7,200,000
Less: fixed expenses	3200000	640000	$3,840,000
Net operating income N	$800,000	$160,000	$960,000
Divisional operating assets D	$4,000,000	1000000	$5,000,000
ROI=N/D*100	20.0	16.0	19.2	%
	ans 1	ans 2	ans 3
ans 4
I would reject the new product line as the rate of return is less than the current rate of return
of the division.
ans 5
As the minimum required rate of return is 15% and the ROI of new product is 16%, hence if it is
added than the company overall ROI will increase.
ans 6
Residual income= Net operating income-(Min required rate of return*net opearting assets)
	in $
a) 800000-(4000000*12%)	320000
b) 160000-(1000000*12%)	40000
C) 960000-(5000000*12%)	360000
As overal residual income increases Dell will accept the new product line
If any doubt please comment. If satisfied you can rate