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ROI and residual income

The overall sales and operating data for two different companies are given below:

Company A Company B

Sales $ 6,000,000 $ 8,000,000
Average Operating Assets $ 1,500,000 $ 2,000,000
Net Operating Profit $ 400,000 $ 200,000
Stockholders' Equity $ 1,000,000 $ 1,500,000
Each firm's minimum rate of return 14 % 12 %
(or Their Respective Cost of Capital)

REQUIRED:

a) Compute the overall ROI for each company.
b) Compute the overall Residual Income for each company.
c) Assume that Company A is presented with an investment opportunity that would require an initial investment in additional operating assets of $100,000 and would yield a ROI and an Internal Rate of Return of 15 %:
--If performance is being measured by ROI would Company A be likely to accept the opportunity? Reject? Why?
--If performance is being measured by residual income, would Company A be likely to accept the opportunity? Reject? Why?
d) Assume that Company B is presented with an investment opportunity that would require an initial investment in additional operating assets of $100,000 and would yield a ROI and an Internal Rate of Return of 15 %:
--If performance is being measured by ROI would Company B be likely to accept the opportunity? Reject? Why?
--If performance is being measured by residual income, would Company B be likely to accept the opportunity? Reject? Why?

Solution Preview

See attached file.

The overall sales and operating data for two different companies are given below:

Company A Company B Total

Sales $6,000,000 $8,000,000 $14,000,000
Average Operating Assets $1,500,000 $2,000,000 $3,500,000
Net Operating Profit $400,000 $200,000 $600,000
Stockholders' Equity $1,000,000 $1,500,000 $2,500,000
Each firm's minimum rate of return 14 % 12 %
(or Their Respective Cost of Capital)

REQUIRED:

a) Compute the overall ROI for ...

Solution Summary

This provides the steps to calculate the ROI and residual income

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