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	$	22,600,000
Variable expenses		14,157,400
Contribution margin		8,442,600
Fixed expenses		6,160,000
Net operating income	$	2,282,600
Divisional average operating assets	$	4,520,000

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

Sales	$9,800,000
Variable expenses	65% of sales
Fixed expenses	$2,595,000

Required:

1. Compute the Office Products Division’s ROI for this year. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

2. Compute the Office Products Division’s ROI for the new product line by itself. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

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. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

6. Suppose that the company’s minimum required rate of return on operating assets is 13% and that performance is evaluated using residual income.

a. Compute the Office Products Division’s residual income for this year.

b. Compute the Office Products Division’s residual income for the new product line by itself.

c. Compute the Office Products Division’s residual income for next year assuming that it performs the same as this year and adds the new product line.

Answer 1

1. Current year ROI for Office Products Division: 50.50%

ROI = Net operating income /Divisional average operating assets = $2282600/$4520000 = 50.50%

2. ROI for new product-line: 34.08%

Net operating income = Sales - Variable expenses - Fixed expenses = $9800000 - $6370000 - $2595000 = $835000

Average net operating assets = $2450000

ROI = $835000/$2450000 = 34.08%

3. ROI = $835000/$2450000 = 34.08%

Total net operating income = $2282600 + $835000 = $3117600

Average operating assets = $4520000 + $2450000 = $6970000

ROI = $3117600/$6970000 = 44.73%

6.

	Invested Assets	Income from Operations	Minimum Rate of Return	Minimum Acceptable Income from Operations	Residual Income
	(A)	(B)	(C)	(D) = (A) x (C)	(E) = (B) - (D)
a.	4520000	2282600	13%	587600	1695000
				(13% x 4520000)	(2282600 - 587600)
b.	2450000	835000	13%	318500	516500
				(13% x 2450000)	(835000 - 318500)
c.	6970000	3117600	13%	906100	2211500
				(13% x 6970000)	(3117600 - 906100)