Problem 12-18 Return on Investment (ROI) and Residual Income [LO12-1, LO12-2]

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 the most recent year are given below:

Sales	$	21,400,000
Variable expenses		13,515,400
Contribution margin		7,884,600
Fixed expenses		5,980,000
Net operating income	$	1,904,600
Divisional operating assets	$	5,350,000

The company had an overall return on investment (ROI) of 16.00% 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 $2,875,000. The cost and revenue characteristics of the new product line per year would be:

Sales	$ 9,200,000
Variable expenses	65% of sales
Fixed expenses	$2,548,400

Required:

1. Compute the Office Products Divisions ROI for the most recent year; also compute the ROI as it would appear if the new product line is added. (Round the "Margin", "Turnover" and "ROI" answers to 2 decimal places.)

	Present		New Line		Total
Sales	$21,400,000		$9,200,000		$30,600,000
Net operating income	$1,904,600
Operating assets	$5,350,000
Margin		%		%		%
Turnover		times		times		times
ROI		%		%		%

2. If you were in Dell Havasis position, would you accept or reject the new product line?

	Accept
	Reject

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

	Adding the new line would Increase the company's overall ROI.
	Adding the new line would Decrease the company's overall ROI.

4. Suppose that the companys minimum required rate of return on operating assets is 13.00% and that performance is evaluated using residual income. a. Compute the Office Products Divisions residual income for the most recent year; also compute the residual income as it would appear if the new product line is added.

	Present		New Line		Total
Operating assets	$5,350,000
Minimum required return		%		%		%
Minimum net operating income
Actual net operating income
Minimum net operating income
Residual income	$0		$0		$0

b. Under these circumstances, if you were in Dell Havasis position, would you accept or reject the new product line?

	Accept
	Reject