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	$	102,000,000
Less: Variable expenses		71,400,000
Contribution margin		30,600,000
Less: Fixed expenses		24,480,000
Net operating income	$	6,120,000
Divisional operating assets	$	17,000,000

The company had an overall ROI of 8.5% 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 $10,200,000. The cost and revenue characteristics of the new product line per year would be as follows:

Sales	$	15,300,000
Variable expenses		70	% of sales
Fixed expenses	$	3,672,000

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%).)

     

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 8.0% 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.

           

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 = 15300000*(1-70%)-3672000= $918000
Margin = Net operating income/Sales
Turnover = Sales/Operating assets
ROI = Margin*Turnover
1
	Present	New line	Total
Sales	102000000	15300000	117300000
Net operating income	6120000	918000	7038000
Operating assets	17000000	10200000	27200000
Margin	6.00%	6.00%	6.00%
Turnover	6.00	1.50	4.31
ROI	36.00%	9.00%	25.88%
2
Reject, as ROI decreases
4a
	Present	New line	Total
Operating assets	17000000	10200000	27200000
Minimum required return	8%	8%	8%
Minimum Net operating income	1360000	816000	2176000
Actual Net operating income	6120000	918000	7038000
Minimum Net operating income	1360000	816000	2176000
RI (Residual income)	4760000	102000	4862000
b
Accept, as residual income increases