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

1. ROI for the most recent year = Net Operating Income / Divisional Operating Assets = $ 1,814,600 / $ 4,220,000 * 100 = 43 %

ROI, if the new product line is added = $ [ 1,814,600 + 633,500] / $ [ 4,220,000 + 2,262, 500 ] * 100 = $ 2,448,100 / $ 6,482,500 * 100 = 37.76 %

2. Reject.

3. Adding the new line would increase the company's overall ROI.

4.a.

Residual income for the most recent year = $ 1,814,600 - $ ( 4,220,000 x 16% ) = $ 1,139,400.

Residual Income if the new product line is added = $ 2,448,100 - $ ( 6,482,500 x 16 %) = $ 1,410,900.

b. Accept.