Share
Explore BrainMass

# 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

\$2.19