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	$	21,750,000
Variable expenses		13,731,600
Contribution margin		8,018,400
Fixed expenses		6,025,000
Net operating income	$	1,993,400
Divisional operating assets	$	4,338,800

The company had an overall return on investment (ROI) of 18.00% 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 $2,126,350. The cost and revenue characteristics of the new product line per year would be:

Sales	$ 9,350,000
Variable expenses	65% of sales
Fixed expenses	$ 2,560,500

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.)

        

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.

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

Net product line net operating income = 9350000*(1-65%)-2560500= $712000
1
Margin = Net operating income/Sales
Turnover = Sales/Operating assets
ROI = Margin*Turnover
	Present	New line	Total
Sales	21750000	9350000	31100000
Net operating income	1993400	712000	2705400
Operating assets	4338800	2126350	6465150
Margin	9.17%	7.61%	8.70%
Turnover	5.01	4.40	4.81
ROI	45.94%	33.48%	41.85%
2
Reject, as ROI decreases
3
Adding the new product line would increase company's overall ROI
4
	Present	New line	Total
Operating assets	4338800	2126350	6465150
Minimum required return	14%	14%	14%
Minimum Net operating income	607432	297689	905121
Actual Net operating income	1993400	712000	2705400
Minimum Net operating income	607432	297689	905121
Residual income	1385968	414311	1800279
b
Accept, as residual income increases