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 ROls. Operating results for the company's Office Products Division for this year are given below: Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets $ 10,000,000 6,000,000 4,000,000 3,200,000 $ 800,000 $ 4,000,000 The company had an overall return on investment (ROI) of 15% 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 $1,000,000. The cost and revenue characteristics of the new product line per year would be:

Answer 1

1	ROI for this year	20.0%
2	ROI for the new product line by itself	16.0%
3	ROI for next year	19.2%

Computations:

1. ROI = Net operating income /Divisional average operating assets = $800000/$4000000 = 20.0%

2. Net operating income = Sales - Variable expenses - Fixed expenses = $2000000 - (60% x $2000000) - $640000 = $160000

Average net operating assets = $1000000

ROI = $160000/$1000000 = 16.0%

3. Total net operating income = $800000 + $160000 = $960000

Average operating assets = $4000000 + $1000000 = $5000000

ROI = $960000/$5000000 = 19.2%

4. Reject

The new product line should be rejected since it would decrease the divisions ROI from 20% to 19.20%

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

Headquarters is anxious to add the new product line since it has a ROI of 16% which is higher than the current overall ROI of 15% and would thus increase the company's overall ROI.

6.

1	Residual income for this year	$ 320,000
2	Residual income for the new product line by itself	$      40,000
3	Residual income for next year	$ 360,000

Computations:

	Invested Assets	Income from Operations	Minimum Rate of Return	Minimum Acceptable Income from Operations	Residual Income
	(A)	(B)	(C)	(D) = (A) x (C)	(E) = (B) - (D)
1	4000000	800000	12%	480000	320000
2	1000000	160000	12%	120000	40000
3	5000000	960000	12%	600000	360000

d. Accept

Since the residual income with the new product line is higher than the current residual income.