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

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“I know headquarters wants us to add that new product line,”said Dell Havasi, manager of Billings Company’s Office ProductsDivision. “But I want to see the numbers before I make any move.Our division’s return on investment (ROI) has led the company forthree years, and I don’t want any letdown.”
Billings Company is a decentralized wholesaler with fiveautonomous divisions. The divisions are evaluated on the basis ofROI, with year-end bonuses given to the divisional managers whohave the highest ROIs. Operating results for the company’s OfficeProducts Division for this year are given below:
Sales $ 22,235,000
Variable expenses 13,981,800
Contribution margin 8,253,200
Fixed expenses 6,100,000
Net operating income $ 2,153,200
Divisional average operatingassets $ 4,625,000
The company had an overall return on investment (ROI) of 17.00%this year (considering all divisions). Next year the OfficeProducts Division has an opportunity to add a new product line thatwould require an additional investment that would increase averageoperating assets by $2,400,000. The cost and revenuecharacteristics of the new product line per year would be:
Sales $9,600,000
Variable expenses 65% ofsales
Fixed expenses $2,582,400
Required:
1. Compute the Office Products Division’s ROI for this year.
2. Compute the Office Products Division’s ROI for the newproduct line by itself.
3. Compute the Office Products Division’s ROI for next yearassuming that it performs the same as this year and adds the newproduct line.
4. If you were in Dell Havasi’s position, would you accept orreject the new product line?
5. Why do you suppose headquarters is anxious for the OfficeProducts Division to add the new product line?
6. Suppose that the company’s minimum required rate of return onoperating assets is 14% and that performance is evaluated usingresidual income.
a. Compute the Office Products Division’s residual income forthis year.
b. Compute the Office Products Division’s residual income forthe new product line by itself.
c. Compute the Office Products Division’s residual income fornext year assuming that it performs the same as this year and addsthe new product line.
d. Using the residual income approach, if you were in DellHavasi’s position, would you accept or reject the new productline?

Answer & Explanation Solved by verified expert

3.6 Ratings (408 Votes)


income on new line
contribution (9,600,000*35%)=			3,360,000
less Fixed expense			-2,582,400
Net operating income			777600


1,2&3)		present	new line	total
	Sales	22,235,000	9,600,000	31,835,000
	Net operating income	2,153,200	777,600	2,930,800
	operating assets	4,625,000	2,400,000	7,025,000
	margin	9.68%	8.10%	9.21%
	turnover	4.81	4.00	4.53
	ROI	46.56%	32.40%	41.72%



	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	4,625,000	2,400,000	7,025,000
	minimum required return	14%	14%	14%
	min net operating income	647500	336000	983500
	actual net operating income	2,153,200	777,600	2,930,800
	min net operating income	647500	336000	983500
	residual income	1,505,700	441,600	1,947,300

b)	Accept

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Transcribed Image Text

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 ProductsDivision. “But I want to see the numbers before I make any move.Our division’s return on investment (ROI) has led the company forthree years, and I don’t want any letdown.”Billings Company is a decentralized wholesaler with fiveautonomous divisions. The divisions are evaluated on the basis ofROI, with year-end bonuses given to the divisional managers whohave the highest ROIs. Operating results for the company’s OfficeProducts Division for this year are given below:Sales$22,235,000Variable expenses13,981,800Contribution margin8,253,200Fixed expenses6,100,000Net operating income$2,153,200Divisional average operatingassets$4,625,000The company had an overall return on investment (ROI) of 17.00%this year (considering all divisions). Next year the OfficeProducts Division has an opportunity to add a new product line thatwould require an additional investment that would increase averageoperating assets by $2,400,000. The cost and revenuecharacteristics of the new product line per year would be:Sales$9,600,000Variable expenses65% ofsalesFixed expenses$2,582,400Required:1. Compute the Office Products Division’s ROI for this year.2. Compute the Office Products Division’s ROI for the newproduct line by itself.3. Compute the Office Products Division’s ROI for next yearassuming that it performs the same as this year and adds the newproduct line.4. If you were in Dell Havasi’s position, would you accept orreject the new product line?5. Why do you suppose headquarters is anxious for the OfficeProducts Division to add the new product line?6. Suppose that the company’s minimum required rate of return onoperating assets is 14% and that performance is evaluated usingresidual income.a. Compute the Office Products Division’s residual income forthis year.b. Compute the Office Products Division’s residual income forthe new product line by itself.c. Compute the Office Products Division’s residual income fornext year assuming that it performs the same as this year and addsthe new product line.d. Using the residual income approach, if you were in DellHavasi’s position, would you accept or reject the new productline?


Sales	$	22,235,000
Variable expenses		13,981,800
Contribution margin		8,253,200
Fixed expenses		6,100,000
Net operating income	$	2,153,200
Divisional average operatingassets	$	4,625,000


Sales	$9,600,000
Variable expenses	65% ofsales
Fixed expenses	$2,582,400