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	$	10,000,000
Variable expenses		6,000,000
Contribution margin		4,000,000
Fixed expenses		3,200,000
Net operating income	$	800,000
Divisional average operating assets	$	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:

Sales	$2,000,000
Variable expenses	60% of sales
Fixed expenses	$640,000

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?

5. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?

Thank you so much!

Answer 1

Net product line net operating income = 2000000*(1-60%)-640000= $160000
Margin = Net operating income/Sales
Turnover = Sales/Operating assets
ROI = Margin*Turnover
	Present	New line	Total
Sales	10000000	2000000	12000000
Net operating income	800000	160000	960000
Operating assets	4000000	1000000	5000000
Margin	8.00%	8.00%	8.00%
Turnover	2.50	2.00	2.40
ROI	20.00%	16.00%	19.20%
1
ROI for this year = 20%
2
ROI for new product line by itself = 16%
3
ROI for next year = 19.2%
4
Reject, as ROI decreases
5
Adding the new product line would increase company's overall ROI