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	$	21,200,000
Variable expenses		13,405,600
Contribution margin		7,794,400
Fixed expenses		5,950,000
Net operating income	$	1,844,400
Divisional average operating assets	$	4,240,000

The company had an overall return on investment (ROI) of 19.00% 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 $2,600,000. The cost and revenue characteristics of the new product line per year would be:

Sales	$9,100,000
Variable expenses	65% of sales
Fixed expenses	$2,538,900

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?

Answer 1

1.
Computation Office Product's Division ROI for the current year
Sales	$21,200,000
Variable expenses	$13,405,600
Contribution margin	$7,794,400
Fixed expenses	$5,950,000
Net operating income	$1,844,400
Divisional average operating assets	$4,240,000
Return on Investment = Net operating income / Average operating assets
Return on Investment = $ 1,844,400 / $ 4,240,000
Return on Investment = 43.50%
2.
Computation Office Product's Division ROI for the new product line
Sales	$9,100,000
Variable expenses	$5,915,000
Contribution margin	$3,185,000
Fixed expenses	$2,538,900
Net operating income	$646,100
Divisional average operating assets	$2,600,000
Return on Investment = Net operating income / Average operating assets
Return on Investment = $ 646,100 / $ 2,600,000
Return on Investment = 24.85%
3.
Computation Office Product's Division ROI for the next year
	Current year	New Product Line	Next Year
Sales	$21,200,000	$9,100,000	$30,300,000
Variable expenses	$13,405,600	$5,915,000	$19,320,600
Contribution margin	$7,794,400	$3,185,000	$10,979,400
Fixed expenses	$5,950,000	$2,538,900	$8,488,900
Net operating income	$1,844,400	$646,100	$2,490,500
Divisional average operating assets	$4,240,000	$2,600,000	$6,840,000
Return on Investment = Net operating income / Average operating assets
Return on Investment = $ 2,490,500 / $ 6,840,000
Return on Investment = 36.41%
4.
Since, ROI % of the new product at 24.85% and the ROI % for next year after adding
the new product at 36.41% is higher than overall ROI % of the company, the new
product line should be accepted.