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 ROls. Operating results for the company's Office Products Division for this year are given below: $22,835,000 14.297.200 Sales axial able Contribut ses Fixed expenses Net operating income 8,537,800 rgin 6,190,000 $2,347,800 Divisional average operating assets $ 4,000,000 The company had an overall return on investment (ROI) of 17.00% 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 $2,755,000. The cost and revenue characteristics of the new product line per year would be: new pr $9,915,000 65% of sales Sales Variable expenses Fixed expenses $2,607,450

Answer 1

ROI = Operating Income/Average Operating Assets ‘

= 2,347,800/4,000,000

= 58.70%

ROI of new product Line = (9,915,000*35% - 2,607,450)/2,755,000

= 31.32%

ROI for next year = (2,347,800+862,800)/(4,000,000+2,755,000)

= 47.53%

Residual Income = Net Operating income – Average operating Assets*Minimum Required rate of return

This year = 2,347,800 – 4,000,000*14%

=$1,787,800

New product line = 862,800 – 2,755,000*14%

= $477,100

Next year = 1,787,800+477,100

= $2,264,900