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 the most recent year are given below:

Sales	$	22,835,000
Variable expenses		14,297,200
Contribution margin		8,537,800
Fixed expenses		6,190,000
Net operating income	$	2,347,800
Divisional operating assets	$	4,000,000

The company had an overall return on investment (ROI) of 17.00% 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 $2,755,000. The cost and revenue characteristics of the new product line per year would be:

Sales	$ 9,915,000
Variable expenses	65% of sales
Fixed expenses	$2,607,450

Required:  

1. 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.)

Find Sales, NOI, Operating Assets, Margin, ROI and Turnover for Present, New Line and Total. Also indicate if each is Favroable or Unfavorable.

2. If you were in Dell Havasi’s position, would you accept or reject the new product line?

	Accept
	Reject

3. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?

	Adding the new line would Increase the company's overall ROI.
	Adding the new line would Decrease the company's overall ROI.

4. Suppose that the company’s minimum required rate of return on operating assets is 14.00% and that performance is evaluated using residual income.

Find Operating Assets, Minimum required return, Minimum net operating income, Actual net operating income , minimum net operating income and residual income for present, new line and total. Indicate Favorable or Unfavorable

a. 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.

b. Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line?

	Accept
	Reject

Answer 1

			ANSWER TO THIS 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 the most recent year are given below:
	Sales	$	22,835,000
	Variable expenses		14,297,200
	Contribution margin		8,537,800
	Fixed expenses		6,190,000
	Net operating income	$	2,347,800
	Divisional operating assets	$	4,000,000
	The company had an overall return on investment (ROI) of 17.00% 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 $2,755,000. The cost and revenue characteristics of the new product line per year would be:
			Sales	$9,915,000
			Variable expenses	65% of sales
			Fixed expenses	$2,607,450
	Required: 1. 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.) Find Sales, NOI, Operating Assets, Margin, ROI and Turnover for Present, New Line and Total. Also indicate if each is Favroable or Unfavorable.
	answer
			present		new line		total
	sales		22,835,000		9915000		32,750,000
	net operating income		2,347,800		862800		3,210,600			margin =	net operating income / sales
	operating asset		4,000,000		2755000		6,755,000			turnover =	sales/total operating assets
	margin		10%	approx	9%	approx	10%	approx		ROI         =	net operating income /OPERATING ASSETS
	turnover		5.70875		3.5989111		4.8482605
	ROI		59%	approx	31%	approx	48%	approx
	NET OPERATING INCOME ON THE NEW LINE IS COMPUTED AS FOLLOWS:
		Sales	$9,915,000
		Variable cost(65% of sales)	$6,444,750
		contribution margin	$3,470,250
		Fixed expenses	$2,607,450
		net operating income	$862,800
	2. If you were in Dell Havasi’s position, would you accept or reject the new product line?
	answer.	REJECT THE NEW ORDER AS IT DILUTES THE ROI AND PERFORMANCES OF DIVISION
	3. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
	ANSWER.
	Adding the new line would Increase the company's overall ROI
	4. Suppose that the company’s minimum required rate of return on operating assets is 14.00% and that performance is evaluated using residual income. Find Operating Assets, Minimum required return, Minimum net operating income, Actual net operating income , minimum net operating income and residual income for present, new line and total. Indicate Favorable or Unfavorable a. 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.
		PRESENT		NEW LINE		TOTAL
	OPERATING ASSETS	4,000,000		2755000		6,755,000
	MINIMUM REQUIRED RETURN	14%		14%		14%
	MINIMUM NET OPERATING INCOME	560000		385700		945700
	ACTUAL NET OPERATING INCOME	2,347,800		862800		3,210,600
	MINIMUM NET OPERATING INCOME	560,000		385,700		945,700
	RESIDUAL INCOME	1,787,800		477,100		2,264,900
	b. Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line?
	ANSWER:
	ACCEPT THE NEW PRODUCT LINE