Question

Capital Investments has three divisions. Each division's required rate of return is 15%. Planned operating results for 2018 are as follows: Division Operating income Investment A $15,000,000 $100,000,000 B $25,000,000 $125,000,000 C $11,000,000 $ 50,000,000 The company is planning an expansion, which will require each division to increase its investments by $25,000,000 and its income by $4,500,000.

Required: a. Compute the current ROI for each division. b. Compute the current residual income for each division. c. Rank the divisions according to their current ROIs and residual incomes. d. Determine the effects after adding the new project to each division's ROI and residual income. e. Assuming the managers are evaluated on either ROI or residual income, which divisions are pleased with the expansion and which ones are unhappy?

Answer 1

a) Calculate following

	Current ROI
A	15000000/100000000 = 15%
B	25000000/125000000 = 20%
C	11000000/50000000 = 22%

b) Current residual income

	Current residual income
A	15000000-(100000000*15%) = 0
B	25000000-(125000000*15%) = 6250000
C	3500000

C) Calculate following

	Current ROI	Rank
A	15000000/100000000 = 15%	3
B	25000000/125000000 = 20%	2
C	11000000/50000000 = 22%	1

d) Current residual income

	Current residual income	Rank
A	15000000-(100000000*15%) = 0	3
B	25000000-(125000000*15%) = 6250000	1
C	3500000	2

e) Calculate following

	ROI	Residual income	Pleased/Unhapped
A	19500000/125000000 = 15.6%	750000	Pleased
B	29500000/150000000 = 19.67%	7000000	Unhappy
C	15500000/75000000 = 20.67%	4250000	Unhappy