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	$	152,500,000
Less: Variable expenses		91,500,000
Contribution margin		61,000,000
Less: Fixed expenses		48,800,000
Net operating income	$	12,200,000
Divisional operating assets	$	61,000,000

The company had an overall ROI of 15.5% 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 $15,250,000. The cost and revenue characteristics of the new product line per year would be as follows:

Sales	$	30,500,000
Variable expenses		60	% of sales
Fixed expenses	$	9,760,000

Required:

1.	Compute the office products division’s ROI for the most recent year; also compute the ROI if the new product line were added. (Do not round intermediate calculations. Round "Percentage" answers to 2 decimal places, (i.e., 0.1234 should be considered as 12.34%).)

     

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

3.	Not available in Connect.

4.	Suppose that the company views a return of 15.0% on invested assets as being the minimum that any division should earn and that performance is evaluated by the RI approach.

a.	Compute the office products division’s RI for the most recent year; also compute the RI as it would appear if the new product line were 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

1)	ROI for the most recent year:
	Sales	15,25,00,000
	Less: Variable expenses	9,15,00,000
	Contribution margin	6,10,00,000
	Less: Fixed expenses	4,88,00,000
	Net operating income	1,22,00,000
	Divisional operating assets	6,10,00,000
	ROI for the most recent year = NOI/Divln OP Assets = 12200000/61000000 =	20.00%
	ROI if the new product line were added:
		Existing	New Product	Total
	Sales	15,25,00,000	30500000	18,30,00,000
	Less: Variable expenses	9,15,00,000	18300000	10,98,00,000
	Contribution margin	6,10,00,000	12200000	7,32,00,000
	Less: Fixed expenses	4,88,00,000	9760000	5,85,60,000
	Net operating income	1,22,00,000	2440000	1,46,40,000
	Divisional operating assets	6,10,00,000	15250000	7,62,50,000
	ROI if the new product line were added = 14640000/76250000 =	19.20%
2)	Reject, as the overall ROI will decrease affecting his bonus.
3)	Requirement not given.
4)
a)	RI for the most recent year:
	NOI	1,22,00,000
	Required return = 61000000*15% =	9150000
	Residual income	30,50,000
	RI if the new product line is added:
	NOI	1,46,40,000
	Required return = 76250000*15% =	11437500
	Residual income	32,02,500
b)	Accept, as the RI increases and will result in higher bonus for the manager.