Question

QUESTION 34

1. The following data pertain to the Belt Division of Allen Corp:

   Average operating assets	$400,000
   Net operating income	$80,000
   Minimum required rate of return	15%
   Current ROI	20%

   The division is evaluated on the basis of residual income. The division is considering a new project that requires a $100,000 investment in operating assets. The project alone will generate $18,000 net operating income (that is 18% ROI).

   Which of the following is true?

   	A.	The division should reject the project. If rejected, the division's residual income will become $25,000.
   	B.	The division should accept the project. If accepted, the division's residual income will become $23,000.
   	C.	The division should accept the project. If accepted, the division's residual income will become $15,000.
   	D.	The division should reject the project. If rejected, the division's residual income will become $19,000.

Answer 1

Current:
Net operating income	80000
Less: Minimum Required return	60000	=400000*15%
Residual income	20000
New investment:
Net operating income	18000
Less: Minimum Required return	15000	=100000*15%
Residual income	3000
Residual income, if accepted	23000	=20000+3000

The division should accept the project. If accepted, the division's residual income will become $23,000.

Option B is correct