Question

"I know headquarters wants us to add on 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 has led the company for three years, and I don't want any letdown." Billings Company is a decentralized organization with five autonomous divisions. The divisions are evaluated on the basis of the return that they are able to generate on invested assets, with year-end bonuses given to the divisional managers who have the highest ROI figures. Operating results for the company's office products division for the most recent year are as follows: Sales Less: Variable expenses $77,500,000 58,125,000 Contribution margin Less: Fixed expenses 19,375,000 15,500,000 Net operating income $ 3,875,000 Divisional operating assets $31,000,000 The company had an overall ROI of 7.0% 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 $7,750,000. The cost and revenue characteristics of the new product line per year would be as follows: Sales Variable expenses Fixed expenses $11,625,000 75% of sales $ 2,325,000

Answer 1

income on new line
contribution					2,906,250
less Fixed expense					-2,325,000
Net operating income					581250
1,2&3)				present	new line	total
	Sales			77,500,000	11,625,000	89,125,000
	Net operating income			3,875,000	581,250	4,456,250
	operating assets			31,000,000	7,750,000	38,750,000
	margin			5.00%	5.00%	5.00%
	turnover			2.50	1.50	2.30
	ROI			12.50%	7.50%	11.50%
	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			31,000,000	7,750,000	38,750,000
	minimum required return			6.5%	6.5%	6.5%
	min net opeerating income			2015000	503750	2518750
	actual net operating income			3,875,000	581,250	4,456,250
	min net operating income			2015000	503750	2518750
	residual income			1,860,000	77,500	1,937,500
b)	Accept