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    Return on Investment and Residual Income

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    Westwood Inc. is a decentralized organization 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:

    Sales $9,000,000
    Variable expenses $5,400,000
    Contribution margin $3,600,000
    Fixed Expenses $2,520,000
    Net Operating Income $1,080,000
    Divisional operating assets $4,500,000

    The company had an overall ROI of 18% 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 $250,000. The cost and revenue characteristics of the new product line per year would be:

    Sales $1,000,000
    Variable expenses 60% of sales
    Fixed expenses $350,000

    Required:
    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.
    2. If you were in Clem Baker's position, would you be inclined to accept or reject the new product line?
    3. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
    4. Suppose that the company's minimum required rate of return on operating assets is 15% 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 Clem Baker's position, would you accept or reject the new product line?

    What type of help I am looking for:

    I have already completed this problem and would like to confirm that I have take the proper steps in completing. Please complete and show step by step how to do the return on investment problem answering required 1- 4.

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    Solution Preview

    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.

    ROI = Net Operating Income/Divisional operating assets
    The current ROI is 1,080,000/4,500,000 = 24%
    If the new product line is added, the operating assets will increase by 250,000 and would be come 4,750,000.
    The operating income from the new line would be
    Sales 1,000,000
    Variable expense 600,000 (60% of sales)
    Fixed Expense 350,000
    Operating Income 50,000
    The new operating income would be 1,080,000+50,000= 1,130,000
    The new ROI is 1,130,000/4,750,000 = ...

    Solution Summary

    The solution explains the calculations relating to Return on Investment and Residual Income

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