Question

Assume Gibson Modems, Inc., is a division of Gilmore Business Products (GBP). GBP uses ROI as the primary measure of managerial performance. GBP has a desired return on investment (ROI) of 5.20 percent. The company has $180,000 of investment funds to be assigned to its divisions. The president of Gibson is aware of an investment opportunity for these funds that is expected to yield an ROI of 5.80 percent.

Income Statement
Sales revenue	$	680,000
Cost of goods sold		(495,000	)
Gross margin	$	185,000
Sales commission		(38,000	)
Depreciation expense		(10,000	)
Administrative expense		(73,550	)
Net income	$	63,450

Balance Sheet
Assets:
Cash	$	728,450
Manufacturing equipment, net of accumulated depreciation		270,000
Office equipment, net of accumulated depreciation		35,000
Total assets	$	1,033,450
Equity:
Common stock	$	970,000
Retained earnings		63,450
Total equity	$	1,033,450

Required

a-1. Calculate the existing ROI for Gibson.

a-2. Based on your computations will the President of Gibson accept or reject the $180,000 investment opportunity?

c-1. Calculate the estimated residual income of the new investment opportunity.

c-2. Based on the residual income would the President of Gibson accept or reject the $180,000 investment opportunity?

Req A1-A2

A1	ROI		%
A2	Will the President of Gibson accept or reject computations?

Req C1-C2

C1	Residual income
C2	Would the President of Gibson accept or reject the residual income?

Answer 1

A1 ANSWER:

ROI = (Net profit/total investment) *100

ROI for Gibson= (63450/180000)*100

=35.25 percent

A2 ANSWER:

Based on computations the president of Gibson reject investment opportunity.Because 35.25 percent is greater than 5.80 percent.

C1 ANSWER:

Residual income= operating income-(operating assets*cost of capital)

RI = 63450-[(728450+270000)*5.80%]

= 63450-[998450*5.8%]

=63450-57910

=5540

C2 ANSWER  

As residual income is net income after getting minimum rate of return and here it shows positive. so, the president of Gibson accept the residual income.