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	$	235,000,000
Less: Variable expenses		164,500,000
Contribution margin		70,500,000
Less: Fixed expenses		56,400,000
Net operating income	$	14,100,000
Divisional operating assets	$	47,000,000

The company had an overall ROI of 11.5% 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 $23,500,000. The cost and revenue characteristics of the new product line per year would be as follows:

Sales	$	47,000,000
Variable expenses		70	% of sales
Fixed expenses	$	11,280,000

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%).)

	present	new line	total
ROI

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 11.0% 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.

	present	new line	total
ROI

           

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 = 47000000*(1-70%)-11280000= $2820000
Margin = Net operating income/Sales
Turnover = Sales/Operating assets
ROI = Margin*Turnover
1
	Present	New line	Total
Sales	235000000	47000000	282000000
Net operating income	14100000	2820000	16920000
Operating assets	47000000	23500000	70500000
Margin	6.00%	6.00%	6.00%
Turnover	5.00	2.00	4.00
ROI	30.00%	12.00%	24.00%
2
Reject, as ROI decreases
4a
	Present	New line	Total
Operating assets	47000000	23500000	70500000
Minimum required return	11%	11%	11%
Minimum Net operating income	5170000	2585000	7755000
Actual Net operating income	14100000	2820000	16920000
Minimum Net operating income	5170000	2585000	7755000
RI(Residual income)	8930000	235000	9165000
b
Accept, as residual income increases