Wednesday, 1 April 2015

“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.”

“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 $ 21,810,000  
  Variable expenses   13,741,200  
 

  Contribution margin   8,068,800  
  Fixed expenses   6,040,000  
 

  Net operating income $ 2,028,800  
 

  Divisional operating assets $ 4,363,000  
 






     The company had an overall return on investment (ROI) of 18.50% 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 $2,350,000. The cost and revenue characteristics of the new product line per year would be:


   
  Sales $ 9,396,500  
  Variable expenses 65% of sales  
  Fixed expenses $ 2,564,875  

 
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.
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Explanation:
1.
     
  Sales $ 9,396,500  
  Variable expenses (65% × $9,396,500)   6,107,725  
 

  Contribution margin   3,288,775   
  Fixed expenses   2,564,875  
 

  Net operating income $ 723,900  
 





2.

Dell Havasi will be inclined to reject the new product line because accepting it would reduce his division’s overall rate of return.

3.

The new product line promises an ROI of 30.80%, whereas the company’s overall ROI last year was only 18.50%. Thus, adding the new line would increase the company’s overall ROI.

4.

Under the residual income approach, Dell Havasi would be inclined to accept the new product line because adding the product line would increase the total amount of his division’s residual income, as shown above.