Question

Adams Company has operating assets of $20,400,000. The company’s operating income for the most recent accounting period was $2,570,000. The Dannica Division of Adams controls $8,360,000 of the company’s assets and earned $1,170,000 of its operating income. Adams’s desired ROI is 9 percent. Adams has $1,050,000 of additional funds to invest. The manager of the Dannica division believes that his division could earn $142,000 on the additional funds. The highest investment opportunity to any of the company’s other divisions is 10 percent.

Required

1. Calculate the ROI of Dannica Division.

1. (1) Before investment opportunity.

2. (2) Only on the new investment opportunity.

3. (3) Dannica total ROI if investment opportunity is accepted.

3. Calculate the Dannica Division residual income from the new investment opportunity. If residual income is used as the sole performance measure would the manager of the Dannica Division be likely to accept or reject the additional funding?

Answer 1

Adams Company
	Option-1	Optio-2	Option-3
	Before Investment	Only New Investment	Total, if Investment Acepted
Operating Income (a)	$1,170,000.00	$142,000.00	$1,312,000.00
Operating Asset (b)	$8,360,000.00	$1,050,000.00	$9,410,000.00
ROI (a/b)	14.00%	13.52%	13.94%

Computation of Residual income
Operating Assets (A)	$1,050,000.00
Minimum Rate Of Return (B)	10%
Minimum Operating Income (C=AxB)	$105,000.00
Net Operating Income (D)	$142,000.00
Residual Income (D-C)	$37,000.00

Yes , new Investment Opportunit should be accpted