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: Sales $ 21,200,000 Variable expenses 13,405,600 Contribution margin 7,794,400 Fixed expenses 5,950,000 Net operating income $ 1,844,400 Divisional operating assets $ 4,240,000 The company had an overall return on investment (ROI) of 19.00% 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 $2,600,000. The cost and revenue characteristics of the new product line per year would be: Sales $ 9,100,000 Variable expenses 65% of sales Fixed expenses $ 2,538,900 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. (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).) 2. If you were in Dell Havasi’s position, would you accept or reject the new product line? Accept Reject 3. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line? Adding the new line would Increase the company's overall ROI. Adding the new line would Decrease the company's overall ROI. 4. Suppose that the company’s minimum required rate of return on operating assets is 16.00% 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. (Enter your Minimum Required Rate as a whole percentage (i.e., 0.12 should be entered as 12).)

I am really confused and am trying to prepare for a test I have coming up soon. Thanks!

Answer 1

1)OFFICE PRODUCTS DIVISION ROI MOST RECENT YEAR AND WHEN NEW PRODUCT LINE ADDED
	OLD LINE	NEW LINE	TOTAL
Sales	21200000	9100000	30300000
Less:Variable expenses	13405600	5915000	19320600
Contribution	7794400	3185000	10979400
fixed cost	5950000	2538900	8488900
Profit	1844400	646100	2490500
operating assets	4240000	2600000	6840000
ROI	43.50%	24.85%	36.41%
2)
REJECT
3)
ADDING THE NEW LINE WOULD DECREASE THE COMPANY OVERAL ROI
4)
OPERATING ASSETS	4240000	2600000	6840000
MINIMUM REQD RATE OF RETURN	16%	16%	16%
MINIMUM NET OPERATING INCOME	678400	416000	1094400
ACTUAL NET OPERATING INCOME	1844400	646100	2490500
RESIDUAL INCOME	1166000	230100	1396100
RESIDUAL INCOME= MINIMUM NET OPERATING INCOME - OPERATING ASSETS* REQD RATE OF RETURN