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	$	21,100,000
Variable expenses		13,350,400
Contribution margin		7,749,600
Fixed expenses		5,935,000
Net operating income	$	1,814,600
Divisional operating assets	$	4,220,000

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 $2,262,500. The cost and revenue characteristics of the new product line per year would be:

Sales	$ 9,050,000
Variable expenses	65% of sales
Fixed expenses	$2,534,000

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 16.00% 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

ROI (Return on Investment) is a profit analyzing ratio in which the profit is shown as a percentage of the investment.

Formula = (Net profit / Investment) * 100

1. Office Product Division's ROI for this year = ( 1814600 / 4220000) * 100 = 43%
For the new product line

Sales = 9050000
Variable Exp (65%) = 5882500
Contribution Margin = 3167500
Fixed Expenses = 2,534,000
Net Operating Income = 633500
Operating Assets = $ 2,262,500

ROI for the new product line by itself = ( 633500 / 2,262,500)*100 = 28%

ROI for the Office Product Division for the next year.
Taken that performance is as of present year added with the new product line together.

Sales = 21,100,000+9050000 = 30150000
Variable Exp = 13,350,400+5882500 = 19232900
Contribution margin = 10917100
Fixed Exp = 5,935,000+2,534,000 = 8469000
Net Operating Income = 2448100
Operating Assets = 4,220,000+2,262,500 = 6482500

Division's ROI for the next year = (2448100 / 6482500 )*100 = 37.76%

2.The new product line causing a decrease in the ROI of the division. Just because of the new product line the ROI will slip from 43.00% to 37.76%. So, if I were in the managers position, I would not accept the project.

3.The company in overall had a ROI of 18% this year. And the new product line has a ROI of 28% of its alone, which is higher that the company's previous ROI. So, if the accept the new product line, it will definitely increase their ROI in total. Thats why the company is anxious for the new product line.

4.a. Required rate of return = 16%
Achieved rate of return = 43%
Residual rate of return = (43-16)% = 27%
Operating assets =  4,220,000
Residual income of the division for most recent year =  4,220,000*27% = $1139400

If the new product line is added
Required rate of return = 16%
Achieved rate of return = 37.76%
Residual rate of return = (37.76-16)% = 21.76%
Operating assets =  6482500
Residual income of the division = 6482500*21.76% = $1410592

4.b. If the performance is evaluated using residual income, then as a manager I would like to accept the new product, as it adds to the total residual value than before.