I know headquarters wants us to add that new product line,” saidDell 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 | $ | 23,000,000 |
| Variable expenses | | 14,365,000 |
| Contribution margin | | 8,635,000 |
| Fixed expenses | | 6,220,000 |
| Net operating income | $ | 2,415,000 |
| Divisional average operating assets | $ | 5,001,000 |
|
The company had an overall return on investment (ROI) of 16.00%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 $2,501,000. The cost and revenuecharacteristics of the new product line per year would be:
| |
| Sales | $10,100,000 |
| Variable expenses | 65% of sales |
| Fixed expenses | $2,644,900 |
|
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 13% 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?
