Question

Help me please.

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 (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 this year are given below $10,000,000 6,000,000 4,000,000 3,200,000 $ Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets $ 4,000,000 800,000 The company had an overall return on investment (ROI) of 15% 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 $1,000,000. The cost and revenue characteristics of the new product line per year would be:

Answer 1

Return on asset is given by net income divided by Average total assets or Profit Margin * Asset Turnover
where Profit Margin = Net income / sales and
Asset turnover = Sales / Average total assets
Billings Company
If the new line is added, then the Net operating Income will be :-
Contribution margin = 2000000 * 40 % = $ 800000
Less:- Fixed expenses = $ 640000
Net operating Income = $ 160000
Part 1, 2 and 3	Present	New line	Total
Sales (a)	10000000	2000000	12000000
Net operating income (b)	800000	160000	960000
Operating assets ©	4000000	1000000	5000000
Margin ( b/a) (d)	8.00%	8.00%	8.00%
Turnover (a/c) (e)	2.5	2	2.4
ROI (d * e)	20.00%	16.00%	19.20%
Part 4- I would reject the order
Part 5- Adding the new line would decrease the company's overall ROI
Part 6 a , b and c	Present	New line	Total
Operating assets (a)	4000000	1000000	5000000
Minimum required return (b)	12%	12%	12%
Minimum NOI ( a*b)	480000	120000	600000
Actual NOI (d)	800000	160000	960000
Minimum NOI (e)	480000	120000	600000
Residual Income ( d-e)	320000	40000	360000
Part 6 d - I would accept the order as residual income increases.