Everett Dockside Company had net operating income of $1,555,000 and average oper

Question

Everett Dockside Company had net operating income of $1,555,000 and average operating assets of $5,000,000. The company requires a return on investment of 19%.

Required:

a. Calculate the company's current return on investment and residual income.

b. The company is investigating an investment of $4,000,000 in project that will generate annual net operating income of $782,000. What is the return on investment of the project? What is the residual income of the project? Should the company invest in this project?

Explanation / Answer

Hi,

Please find the answer as follow:

Part A:

Return on Investment = Net Operating Income/Average Operating Assets*100 = 1555000/5000000*100 = 31.1%

Residual Income = Operating Income - Operating Assets*Required Rate of Return = 1555000 - 5000000*.19 = 605000

Part B:

Return on Investment = Net Operating Income/Average Operating Assets*100 = 782000/4000000*100 = 19.55%

Residual Income = Operating Income - Operating Assets*Required Rate of Return = 782000 - 4000000*.19 = 22000

Yes, the company should invest in the project as its rate of return is higher than the minimum required rate of return. Or we can also say, that investment can be made because project has a + residual value.

Thanks.

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