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Residual Income and ROI Possibility

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An investment center in Shellforth Corporation was asked to identify three proposals for its capital
budget. Details of those proposals are:

Capital Budget Proposals
A B C
Capital required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $80,000 $50,000 $150,000
Annual operating return . . . . . . . . . . . . . . . . . . . . . . . . . . 24,000 16,000 15,000

Shellforth uses residual income to evaluate all capital budgeting projects. Its minimum required
return is 12 percent.

a. Assume you are the investment center manager. Which project do you prefer? Why?

b. Assume your investment center's current ROI is 18 percent and that the president of Shellforth
is thinking about using ROI for the investment center's evaluation. Would your preferences for
the projects listed above change? Why?

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Solution Summary

An investment center in Shellforth Corporation was asked to identify three proposals for its capital
budget. Details of those proposals are:
Capital Budget Proposals
A B C
Capital required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $80,000 $50,000 $150,000
Annual operating return . . . . . . . . . . . . . . . . . . . . . . . . . . 24,000 16,000 15,000
Shellforth uses residual income to evaluate all capital budgeting projects. Its minimum required
return is 12 percent.
a. Assume you are the investment center manager. Which project do you prefer? Why?
b. Assume your investment center's current ROI is 18 percent and that the president of Shellforth
is thinking about using ROI for the investment center's evaluation. Would your preferences for
the projects listed above change? Why?

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