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

Question

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 Company's Office Products Division. But I want to see the numbers before I make any move. Our division's return on investment (RO) 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 Sales Variable expenses Contribution margin Pixed expenses Net operating income Divisional average operating assets 21,902,000 13,788,600 ,113,400 055,000 2 058,400 4,562,500 The company had an overall return on investment (ROI) of 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 $2,250,500. The cost and revenue characteristics of the new product line per year would be: alen Variable expenses Pixed expenses 9,450,000 sales 65% of 2,570,200 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.

Explanation / Answer

Req 1. Office division ROI: Net Income for the year 2058400 Divide: Average operating assets 4562500 ROI of Office division 45.12% Req 2. ROI of new product: Sales of new product 9450000 Less: Variable expenses 6142500 Less: Fixed expense 2570200 Net income 737300 Divide: Incremental operating assets 2250500 ROI of new product: 32.76% Req 3. Combined ROI of next year: Net Income (2058400+737300) 2795700 Divide: Total Assets (4562500+2250500) 6813000 Combined ROI of next year: 41.03% Req 6-a: Residual Income: Operating assets 4562500 target ROI 18% Target Residual income 821250 Actual Net income 2058400 Residual Income: 1237150 Req 6-b: Residual Income of new product: Incremental Assets 2250500 Target Roi 18% Target Income of New product 405090 Net income of new product 737300 Residual Income of new product: 332210 Req 6-c: Total Net income (2058400+737300) 2795700 Total assets (4562500+2250500) 6813000 ROI 18% Target Income 1226340 Residual Income 1569360

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