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Evaluating New Investments Using Return on Investment and Residual Income

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Evaluating New Investments Using Return on Investment (ROI) and Residual Income [LO2, LO3]

Selected sales and operating data for three divisions of three different companies are given below:

Division A Division B Division C
Sales $ 6,000,000 $ 10,000,000 $ 8,000,000
Average operating assets $ 1,500,000 $ 5,000,000 $ 2,000,000
Net operating income $ 300,000 $ 900,000 $ 180,000
Minimum required rate of return 15 % 18 % 12 %
________________________________________

Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Omit the "%" sign in your response.)

ROI
Division A
%
Division B
%
Division C
%
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Compute the residual income for each division. (Negative amounts should be indicated by a minus sign. Leave no cells blank, enter "0" as required. Omit the "$" sign in your response.)

Division A Division B Division C
Residual income $
$
$
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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 divisions will probably accept the opportunity? Reject?

Division A
Division B
Division C
________________________________________

(b) If performance is being measured by residual income, which division or divisions will probably accept the opportunity? Reject?

Division A
Division B
Division C

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The solution explains how to evaluate new investments using Using Return on Investment (ROI) and Residual Income

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