Homework SourseI know headquarters wants us to add that new product line sa
“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:
The company had an overall return on investment (ROI) of 16.00% 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 $2,450,000. The cost and revenue characteristics of the new product line per year would be:
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. (Round the \"Margin\", \"Turnover\" and \"ROI\" answers to 2 decimal places.)
If you were in Dell Havasi’s position, would you accept or reject the new product line?
Suppose that the company’s minimum required rate of return on operating assets is 13.00% and that performance is evaluated using residual income.
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.
| “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.” |
Solution
Solution:
1)
Calculation of ROI
Present
New Line
Total
Sales
$22,600,000
$9,800,000
$32,400,000
Net Operating Income
$2,282,600
$835,000
$3,117,600
Operating Assets
$4,520,000
$2,450,000
$6,970,000
Margin
(Net Operating Income / Sales x 100)
10.10
%
8.52
%
9.62
%
Turnover
(Sales / Operating Assets)
5.00
4.00
4.65
ROI (Margin x Turnover)
50.50
%
34.08
%
44.73
%
Note:
Calculation of Net Profit from New Line
Sales
$9,800,000
Less: Variable Cost (65% of Sales)
$6,370,000
Contribution Margin
$3,430,000
Less: Fixed Cost
$2,595,000
Net Operating Profit
$835,000
2)
Decision related to accept of reject new product line based on residual income
Present
New Line
Total
Operating Assets
$4,520,000
$2,450,000
$6,970,000
Minimum required return
13.00
%
13.00
%
13.00
%
Minimum Net Operating Income
(Operating Assets x Minimum required return)
$587,600
$318,500
$906,100
Actual Net Operating Income
$2,282,600
$835,000
$3,117,600
Minimum Net Operating Income
$587,600
$318,500
$906,100
Residual Income / (loss)
(Actual Net Operating Income - Minimum Net Operating Income)
$1,695,000
$516,500
$2,211,500
Yes, New Product Line should be accepted because residual income from new product line is positive & the overall residual income of company will increase.
| Present | New Line | Total | ||||
| Sales | $22,600,000 | $9,800,000 | $32,400,000 | |||
| Net Operating Income | $2,282,600 | $835,000 | $3,117,600 | |||
| Operating Assets | $4,520,000 | $2,450,000 | $6,970,000 | |||
| Margin (Net Operating Income / Sales x 100) | 10.10 | % | 8.52 | % | 9.62 | % |
| Turnover (Sales / Operating Assets) | 5.00 | 4.00 | 4.65 | |||
| ROI (Margin x Turnover) | 50.50 | % | 34.08 | % | 44.73 | % |
