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 this year are given below:

Sales	$	22,045,000
Variable expenses		13,882,000
Contribution margin		8,163,000
Fixed expenses		6,070,000
Net operating income	$	2,093,000
Divisional average operating assets	$	5,500,000

The company had an overall return on investment (ROI) of 16.00% 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 $2,501,500. The cost and revenue characteristics of the new product line per year would be:

Sales	$9,500,000
Variable expenses	65% of sales
Fixed expenses	$2,574,100

Required:

1. Compute the Office Products Division’s ROI for this year.

2. Compute the Office Products Division’s ROI for the new product line by itself.

3. Compute the Office Products Division’s ROI for next year assuming that it performs the same as this year and adds the new product line.

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

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

6. Suppose that the company’s minimum required rate of return on operating assets is 13% and that performance is evaluated using residual income.

a. Compute the Office Products Division’s residual income for this year.

b. Compute the Office Products Division’s residual income for the new product line by itself.

c. Compute the Office Products Division’s residual income for next year assuming that it performs the same as this year and adds the new product line.

d. Using the residual income approach, if you were in Dell Havasi’s position, would you accept or reject the new product line?

Answer 1

Part 1 & 6.a
	Computation of ROI of Office Product Division this year
		Office Product Division
	Sales	$2,20,45,000
	Variable expenses	$1,38,82,000
	Contribution Margin	$81,63,000
	Fixed Costs	$60,70,000
	Net Opeating Income	$20,93,000
	Divisional Operating Assets	$55,00,000
	ROI(Net Operating Income / Divisional Operating Assets)	38.05%
	Residual Income[Net Income-(Average Invested assets*13%)]	$13,78,000
Part 2 & 6.b
	Computation of ROI of New Product line by itself only
		New Product line
	Sales	$95,00,000
	Variable expenses	$61,75,000
	Contribution Margin	$33,25,000
	Fixed Costs	$25,74,100
	Net Opeating Income	$7,50,900
	Divisional Operating Assets	$25,01,500
	ROI(Net Operating Income / Divisional Operating Assets)	30.02%
	Residual Income[Net Income-(Average Invested assets*13%)]	$4,25,705
Part 3 & 6.c
	Computation of ROI of Office Product Division after adding New product
		Office Product Division with new poduct line
	Sales	$3,15,45,000
	Variable expenses	$2,00,57,000
	Contribution Margin	$1,14,88,000
	Fixed Costs	$86,44,100
	Net Opeating Income	$28,43,900
	Divisional Operating Assets	$80,01,500
	ROI(Net Operating Income / Divisional Operating Assets)	35.54%
	Residual Income[Net Income-(Average Invested assets*13%)]	$18,03,705
Part 4	Since after the new product line is launched the ROI has decreased from 38.05% to 35.54% hence the new product line should not be added.
Part 6.d	As per Residual Income approach the new product line should be added