Question

Problem 9-18A Return on Investment (ROI) and Residual Income [LO9-1, LO9-2]

“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	$	22,000,000
Variable expenses		13,500,000
Contribution margin		8,500,000
Fixed expenses		6,000,000
Net operating income	$	2,500,000
Divisional operating assets	$	4,443,500

The company had an overall return on investment (ROI) of 16.00% 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 $2,289,300. The cost and revenue characteristics of the new product line per year would be:

Sales	$ 9,155,000
Variable expenses	65% of sales
Fixed expenses	$ 2,543,950

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. (Do not round intermediate calculations. Round your Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

        

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.

Answer 1

Net product line net operating income = 9155000*(1-65%)-2543950= $660300
1
Margin = Net operating income/Sales
Turnover = Sales/Operating assets
ROI = Margin*Turnover
	Present	New line	Total
Sales	22000000	9155000	31155000
Net operating income	2500000	660300	3160300
Operating assets	4443500	2289300	6732800
Margin	11.36%	7.21%	10.14%
Turnover	4.95	4.00	4.63
ROI	56.26%	28.84%	46.94%
	or 56.23%		or 46.95%
2
Reject, as total ROI decreases
3
Adding the new product line would increase company's overall ROI