Che \"I know headquarters wants us to add that new product line\" said Dell Hava
ID: 2524138 • Letter: C
Question
Che "I know headquarters wants us to add that new product line" said Dell Havasi, manager of Billings Company's Office Products Drision "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 ROls. Operating results for the company's Office Products Division for this year are given below Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets $ 21,60e,888 7,977,488 6,010,000 $ 4,499,200 The company had an overall return on investment (ROI) of 1700% 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 $2,326,200. The cost and revenue characteristics of the new product line per year would be: $9,300,808 65% of sales Sales Variable expenses Fixed expenses $2,557,400Explanation / Answer
1) Office Products Division's ROI for this year = 1967400/4499200 = 43.73% 2) Sales 9300000 Variable expenses 6045000 Fixed expenses 2557400 NOI 697600 ROI=697600/2326200= 29.99% 3) ROI = (1967400+697600)/(4499200+2326200)= 39.05% 4) No, as the total ROI will decrease from 43.73% to 39.05% if the new product line is added. Decrease in ROI will affect performance evaluation and reduce bonuses. 5) Head Quarters is anxious to add the new product line as it would result in increase in NOI. 6) a) NOI 1967400 Required return on operating assets = 4499200*14% = 629888 Residual Income 1337512 b) NOI 697600 Required return on operating assets = 2326200*14% = 325668 Residual Income 371932 c) NOI 2665000 Required return on operating assets = (4499200+2326200)*14% = 955556 Residual Income 1709444 d) Yes, as the total RI will increase, resulting in higher bonus.