"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 (ROI) 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 ROIs. Operating results for the company's Office Products Division for the most recent year are given below:
Variable expenses: 13,893,400
Contribution margin: 8,206,600
Fixed expenses: 6,085,000
Net operating income: $2,121,600
Divisional operating assets: $5,200,000
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 $2,387,500. The cost and revenue characteristics of the new product line per year would be: Sales ($ 9,550,000), Variable expenses (65% of sales), and Fixed expenses ($ 2,578,500)
1. Compute the Office Products Division's 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.)
2. If you were in Dell Havasi's position, would you accept or reject the new product line? Accept or Reject
3. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line? Increase overall ROI or decrease overall ROI?
4. Suppose that the company's minimum required rate of return on operating assets is 12.00% and that performance is evaluated using residual income.
a. Compute the Office Products Division?s residual income for the most recent year; also compute the residual income as it would 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? Accept Reject
Return on investment and residual income .
ROI can be defined as the ratio between the net earnings of a company and the total investment used to earn such earnings. Residual income can be defined as the amount of earnings over and above the amount of earnings calculated by the minimum rate of return of a business.
Answer and Explanation:
Compute the ROI as required by using the below formula:
ROI = Net profit/ Total investment = Net profit/ Total assets
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fromChapter 25 / Lesson 6