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Important information about Calculating Residual Income and Return on Investment

The Clipper Corporation had net operating income of $380,000 and average operating assets of $2,000,000. The corporation requires a return on investment of 18%.

Required:

a. Calculate the company's return on investment (ROI) and residual income (RI).

b. Clipper Corporation is considering an investment of $70,000 in a project that will generate annual net operating income of $12,950. Would it be in the best interests of the company to make this investment?

c. Clipper Corporation is considering an investment of $70,000 in a project that will generate annual net operating income of $12,950. If the division planning to make the investment currently has a return on investment of 20% and its manager is evaluated based on the division's ROI, will the division manager be inclined to request funds to make this investment?

d. Clipper Corporation is considering an investment of $70,000 in a project that will generate annual net operating income of $12,950. If the division planning to make the investment currently has a residual income of $50,000 and its manager is evaluated based on the division's residual income, will the division manager be inclined to request funds to make this investment?

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Solution:

A. Calculate the company's return on investment (ROI) and residual income (RI).

ROI=Net operating income/Average operating assets=380000/2000000=19%
Required income=Average operating assets*required rate of return
=2000000*18%
=$360000
Residual Income=Net operating income-Required income
= $380000-$360000
=$20000

B. Clipper Corporation is considering an investment of $70,000 in a project that will ...

Solution Summary

Solution describes the methodology to calculate residual income and return on investment. It also shows the decisions taken based upon these two parameters.

$2.19