Reference no: EM133118032
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 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 this year are given below:
Sales $21,000,000
Variable expenses 13,400,000
Contribution margin 7,600,000
Fixed expenses 5,920,000
Net operating income $1,680,000
Divisional average operating assets $5,250,000
The company had an overall return on investment (ROI) of 18.00% 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 $3,000,000. The cost and revenue characteristics of the new product line per year would be:
Sales $9,000,000
Variable expenses 65% of sales
Fixed expenses $2,520,000
Required -
1. Compute the Office Products Division's ROI for this year.
2. Compute the Office Products Division's ROI for the new product line by itself.
3. If you were in Dell Havasi's position, would you accept or reject the new product line?
4. Why do you suppose that the Office products Division is anxious to add the new product line?
5. Suppose that the company's minimum required rate of return on operating assets is 15% and that performance is evaluated using residual income.
(a) Compute the Division's residual income for last year and this year when the new product line is added.
(b) Under these circumstances, would you accept or reject the new product line?
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