P127 Return on investment (ROI) and residual income I know headquarters wants us to add on that
Question:
P12–7 Return on investment (ROI) and residual income
‘I know headquarters wants us to add on 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 has led the company for three years, and I don’t want any letdown.’
Billings Company is a decentralized organization with five autonomous divisions. The divisions are evaluated on the basis of the return that they are able to generate on invested assets, with year-end bonuses given to the divisional managers who have the highest ROI figures. Operating results for the company’s Office Products Division for the most recent year are given below:
The company had an overall ROI of 15% 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 £1,000,000. The cost and revenue characteristics of the new product line per year would be:
Requried 1 Compute the Office Products Division’s ROI for the most recent year; also compute the ROI as it will appear if the new product line is added.
2 If you were in Dell Havasi’s position, would you be inclined to accept or reject the new product line? Explain.
3 Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
4 Suppose that the company views a return of 12% on invested assets as being the minimum that any division should earn and that performance is evaluated by the residual income approach.
5
(a) Compute the Office Products Division’s residual income for the most recent year; also compute the residual income as it will appear if the new product line is added.
(b) Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line? Explain.
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