“I know headquarters wants us to add that new product line,” said Dell Havasi, m

ID: 2465018 • Letter: #

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 the most recent year are given below:

The company had an overall return on investment (ROI) of 16.00% 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 $2,450,000. The cost and revenue characteristics of the new product line per year would be:

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. (Round the "Margin", "Turnover" and "ROI" answers to 2 decimal places.)

If you were in Dell Havasi’s position, would you accept or reject the new product line?

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

Explanation / Answer

Present :

Margin = Net Operating Income / Sales = 2,282,600/22,600,000 = 10.1%

Turnover = Sales/Average operating assets = 22,600,000/4,520,000 = 5

ROI = Margin X Turnover = 10.1% X 5 = 50.5%

Now, Income statement of New Line:

Sales 9,800,000

Less: Variable cost (65%b of sales) 6,370,000

Contribution Margin 3,430,000

Less: Fixed Expenses 2,595,000

Net operating Income 835,000

New :

Margin = Net Operating Income / Sales = 835,000/9,800,000 = 8.52%

Turnover = Sales/Average operating assets = 9,800,000/2,450,000 = 4

ROI = Margin X Turnover = 8.52% X 4 = 34.08%

Total:

Margin = Net Operating Income / Sales = 3,117,600/32,400,000 = 9.62%

Turnover = Sales/Average operating assets = 32,400,000/6,970,000 = 4.64

ROI = Margin X Turnover = 9.62% X 4.64 = 44.71%

2. The new product line will be rejected as the ROI is getting reduced to 44.71% from 50.5%.

3. Adding the new line would decrease the company's overall ROI

Present New Line Total Sales 22,600,000 9,800,000 32,400,000 Net operating income 2,282,600 835,000 3,117,600 Operating assets 4,520,000 2,450,000 6,970,000 Margin 10.1 % 8.52 % 9.62 % Turnover 5 4 4.64 ROI 50.5 % 34.08 % 44.71 %

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“I know headquarters wants us to add that new product line,” said Dell Havasi, m

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“I know headquarters wants us to add that new product line,” said Dell Havasi, m

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