Question

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.
$Answer

(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.)
Answer

2. Compute the Mustang Division's residual income if the project is undertaken.
$Answer

Answer 1

a) Return on Investment = Operating Income/Investment X 100

= 700000/4000000 X 100 = 17.50 Percent.

b) Residual income = Actual Return - Terget Return

= 700000 - (4000000X16%)

= 700000 - 640000 = ?60,000

??c) 1) Revised Operating income = (700000+200000) = 900000

   Revised Investment = 4000000+950000 = 4950000

   Therefore Return on Investment = 900000/4950000 X 100 = 18.181 Percent.

2) Residual income = 900000 - (4950000X16%)

   = 900000 - 792000 = ?1,08,000

Thank You.