Problem 10-18 Return on Investment (ROI) and Residual Income [LO10-1, LO10-2]

I know headquarters wants us to add that new product line, said Dell Havasi, manager of Billings Companys Office Products Division. But I want to see the numbers before I make any move. Our divisions return on investment (ROI) has led the company for three years, and I dont 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 companys Office Products Division for this year are given below:

Sales	$	21,500,000
Variable expenses		13,565,000
Contribution margin		7,935,000
Fixed expenses		5,995,000
Net operating income	$	1,940,000
Divisional average operating assets	$	4,301,500

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 $2,313,700. The cost and revenue characteristics of the new product line per year would be:

Sales	$9,255,000
Variable expenses	65% of sales
Fixed expenses	$2,552,650

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

6. Suppose that the companys minimum required rate of return on operating assets is 14% and that performance is evaluated using residual income.

a. Compute the Office Products Divisions residual income for this year.

b. Compute the Office Products Divisions residual income for the new product line by itself.