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Evaluating New Investment Using Return on Investment (ROI) and Residual Income

E12-10
Evaluating New Investment Using Return on Investment and Residual Income.
Division A Division B Division C
Sales 6000000 10000000 8000000
Average operating assets 1500000 5000000 2000000
Pretax income 300000 900000 180000
Minimum required rate of return 15% 18% 12%

1. Compute the return on investment (ROI) for each division.
2. Compute the residual income for each division.
3. Assume that each division is presented with an investment opportunity that would yield a rate of return of 17%.
a. If performance is being measured by ROI, which division or division will probably accept the opportunity? Reject? Why?
b. If performance is being measured by residual income, which division or division will probably accept the opportunity? Reject? Why?

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Solution Summary

The solution calculates the ROI and the residual income for three divisions together with explanations and conclusions.

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