Question

Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets $ 21,100,eee 13,350,48e 7,749,6ee 5,935,e00 $ 1,814,600 $ 4,220,00e The company had an overall return on investment (ROI) of 18.00 % 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 $2,262,500. The cost and revenue characteristics of the new product line per year would be: Sales Variable expenses Fixed expenses $9,0se,000 65% of sales $2,534,000 Required: 1. Compute the Office Products Division's ROl 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? 6. Suppose that the company's minimum required rate of return on operating assets is 16% and that performance is evaluated using residual income.

Answer 1

1.ROI = Net Operating Income/Average Assets

= 1,814,600/4,220,000

= 43%

2.ROI of new product line = (9,050,000*35%-2,534,000)/2,262,500

= 28%

3.ROI when new line is added

= (1,814,600+ 633,500)/6,482,500

= 37.76%

4.Reject, since will reduce ROI

5.Because ROI of new line is higher than the overall ROI of the company

4.Residual Income = Net operating Income – Average operating assets*Minimum required rate of return

a.Office Products residual income = 1,814,600 – 4,220,000*16%

= $1,139,400

b.New Product Line added = 633,500 – 2,262,500*16%

= $271,500

c.Residual Income = 1,139,400+271,500 = $1,410,900

d.Accept as Residual Income has increased