Question

Please answers : Round your answer to three decimal places

ROI and Residual Income:
Impact of a New Investment

The Mustang Division of Detroit Motors had an operating income of $700,000 and net assets of $4,000,000. Detroit Motors has a target rate of return of 16 percent.

(a) Compute the return on investment. (Round your answer to three decimal places.)
Answer

(b) Compute the residual income.
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(c) The Mustang Division has an opportunity to increase operating income by $200,000 with an $950,000 investment in assets.

1. Compute the Mustang Division's return on investment if the project is undertaken. (Round your answer to three decimal places.)
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2. Compute the Mustang Division's residual income if the project is undertaken.
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Answer 1

Answer a.

Return on Investment = Operating Income / Net Assets
Return on Investment = $700,000 / $4,000,000
Return on Investment = 17.50%

Answer b.

Residual Income = Operating Income - Rate of Return * Net Assets
Residual Income = $700,000 - 16% * $4,000,000
Residual Income = $60,000

Answer c.

New Operating Income = $700,000 + $200,000
New Operating Income = $900,000

New Net Assets = $4,000,000 + $950,000
New Net Assets = $4,950,000

Return on Investment = Operating Income / Net Assets
Return on Investment = $900,000 / $4,950,000
Return on Investment = 18.18%

Residual Income = Operating Income - Rate of Return * Net Assets
Residual Income = $900,000 - 16% * $4,950,000
Residual Income = $108,000