Question

The ABC division has a current IOD of 14 percent. The companu tatarget ROI os 10 %. The ABC Division has an opportunity to invest $5,400,000 at 12% but is relucant to do so because its ROI will fall to 13.20%. The present investment base for the the division is $8,100,000.

1. Caculate the current residual income and the residual income with the new investment opportunity being included.

2. Should ABC Division make the investment?

Answer 1

1)

Residual income (RI) = income - capital interest

Current RI

= $0.81-($8.1 milion × 14%)

RI = (0.324)milliom

Workings :

We know ROI = Income / capital investment × 100

Income = ROI × capital investment

= 10% × 8.1 million

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Revised RI

= $1.782 - ($8.5+5.4m × 12%)

= $ 0.162 million.

Working :

Income = 13.2% × $13.5 m

= $1.782 m

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2) when the company is invested in new project the RI had been incresed from ($0.324m) to $0.162 milion

It is a notable increase of negative to a possitive value , so the investment is benifitial and accepted my the management