Exercise 15-17 Comparing return on investment with residual income LO 15-6, 15-7

Question

Exercise 15-17 Comparing return on investment with residual income LO 15-6, 15-7 The Monarch Division of Allgood Corporation has a current ROI of 12 percent. The company target ROI is 8 percent. The Monarch Division has an opportunity to invest $3,000,000 at 10 percent but is reluctant to do so because its ROI will fall to 11.50 percent. The present investment base for the division is $9,000,000. Required Calculate the current residual income and the residual income with the new investment opportunity being included. Based on your answers to requirement a, should Monarch Division make the investment?

Explanation / Answer

1) a) Current residual income : $360,000

Working: $9,000,000 * (12% - 8% ) = 360,000

b) New residual income: $420,000

Working: ($9,000,000 + $3,000,000) * (11.5% - 8%)

2) YES, Monarch Division should make the investment

Working: Because new residual income exceeds current residual income thus should avail the opportunity

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