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 $85,000,000 55,250,000 Less: Variable expenses Contribution margin Less: Fixed expenses 29,750,000 23,800,000 $ 5,950,000 Net operating income Divisional operating assets $17,000,000 The company had an overall ROI of 13.0% 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 $8,500,000. The cost and revenue characteristics of the new product line per year would be as follows: $17,000,000 Sales Variable expenses Fixed expenses 65% of sales $ 4,760,000 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%).)

Answer 1

Part 1
Income Statement	Present	New Line	Total
Sales	$85,000,000	$17,000,000	$102,000,000
Variable expenses	$55,250,000	$11,050,000	$66,300,000
Contribution margin	$29,750,000	$5,950,000	$35,700,000
Fixed expenses	$23,800,000	$4,760,000	$30,600,000
Net operating income	$5,950,000	$1,190,000	$7,140,000
a)	Present	New Line	Total
Sales	$85,000,000	$17,000,000	$102,000,000
Net operating income	$5,280,000	$1,190,000	$7,140,000
Operating assets	$17,000,000	$8,500,000	$25,500,000
Margin % = NOI/Sales	7.00%	7.00%	7.00%
Asset Turnover = sales/operating assets	5.00	2.00	4.50
ROI = Margin% x Asset Turnover	35.00%	14.00%	28.00%
2)
Dell Havasi will reject the new product line as it would reduce his division’s overall rate of return.
3)
4)
a)	Present	New Line	Total
Operating assets	$17,000,000	$8,500,000	$25,500,000
Minimum required return	x 12%	x 12%	x 12%
Minimum net operating income	$2,040,000	$1,020,000	$3,060,000
Actual net operating income	$5,950,000	$1,190,000	$7,140,000
Minimum net operating income (above)	$2,040,000	$1,020,000	$3,060,000
Residual income	$3,910,000	$170,000	$4,080,000