Question

# “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 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 \$ 21,600,000 Variable expenses 13,622,600 Contribution margin 7,977,400 Fixed expenses 6,010,000 Net operating income \$ 1,967,400 Divisional average operating assets \$ 4,499,200

The company had an overall return on investment (ROI) of 17.00% 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 \$2,326,200. The cost and revenue characteristics of the new product line per year would be:

 Sales \$9,300,000 Variable expenses 65% of sales Fixed expenses \$2,557,400
 1. ROI for this year % 2. ROI for the new product line by itself % 3. ROI for next year %

6. Suppose that the company’s minimum required rate of return on operating assets is 14% and that performance is evaluated using residual income.

 1. Residual income for this year 2. Residual income for the new product line by itself 3. Residual income for next year

 Net operating income new product line=9300000*(1-0.65)-2557400= \$697600 1 ROI for this year 43.73% =1967400/4499200 ROI for the new product line by itself 29.99% =697600/2326200 ROI for next year 39.05% =(1967400+697600)/(4499200+2326200) 6 Residual income for this year 1337512 =1967400-(4499200*14%) Residual income for the new product line by itself 371932 =697600-(2326200*14%) Residual income for next year 1709444 =1337512+371932

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