Return on investment measurement
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Green company has prepared the following information for three of its divisions: (see attached)
Division Historical cost of investments Division operating income
X $560,000 $66,500
Y 532,000 64,400
Z 350,000 43,120
a. Compute each division's return on investment and residual income, assuming a 10% cost of capital
b.Suppose the net book value of each division's investments is half of the historical cost. Using net book value as the measure of investment, compute each division's return on investment and residual income, assuming a 10% cost of capital.
c. Comment on the division's rankings in (a) and (b)
d. If the division managers are rewarded on the basis of return on investment or residual income, will they find it attractive to invest in new, more costly equipment?
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Excel file contains steps and computation of Return on investment and residual income of three divisions.
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