I know headquarters wants us to add that new product line, said Dell Havasi, man
ID: 2532059 • Letter: I
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 ROl, with year-end bonuses given to the divisional managers who have the highest ROls. Operating results for the company's Office Products Division for the most recent year are given below: Sales $ 21,600,000 Variable expenses 13,622,600 Contribution margin 7,977,400 Fixed expenses Net operating income Divisional operating assets 6,010,000 $ 1,967,400 $ 4,499,200 The company had an overall return on investment (ROI) of 17.00% 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 $2,326,200. The cost and revenue characteristics of the new product line per year would be Sales Variable expenses Fixed expenses $ 9,300,000 65% of sales $ 2,557,400Explanation / Answer
Solution 1:
Operating income for new line = $9,300,000 - $9,300,000*65% - $2,557,400 = $697,600
Solution 2:
As ROI is decreasing on adding new product line, therefore new product line should be rejected.
Solution 3:
As new product line is having ROI greater than ROI of company i.e. 17%, therefore adding new product line will increase overall ROI of the company. That's why headquarter is anxious for the office product division to add the new product line.
Solution 4 a:
Solution 4b:
If performance is evaluated using residual income, then residual income is increasing on adding new product line, therefore new product line should be accepted.
Computation of ROI of Product Division Particulars Present New Line Total Sales $21,600,000.00 $9,300,000.00 $30,900,000.00 Net Operating Income $1,967,400.00 $697,600.00 $2,665,000.00 Operating Assets $4,499,200.00 $2,326,200.00 $6,825,400.00 Margin (Net operating income / Sales) 9.11% 7.50% 8.62% Turnover (Sale / Operating Assets) 4.80 4.00 4.53 ROI (Margin * Turnover) 43.73% 29.99% 39.05%