Return on Investment and Investment Decisions Leslie Blandings, division manager

Question

Return on Investment and Investment Decisions Leslie Blandings, division manager of Audiotech Inc., was debating the merits of a new product-a weather radio that would put out a warning if th county in which the listener lived were under a severe thunderstorm or tornado alert. The budgeted income of the division was $875,000 with operating assets of $5,125,000. The proposed investment would add income of $640,000 and would require an additional investment in equipment of $4,000,000. The minimum required return on investment for the company is 12%. Required: 1. Compute the ROl of the following (round to the nearest whole percent) a. The division if the radio project is not undertaken. b. The radio project alone. The division if the radio project is undertaken. 2. Compute the residual income of the folowing: a. The division if the radio project is not undertaken b·The radio project alone: c. The division if the radio project is undertaken 3. This depends on whether Lesle's division is evaluated on the basis of ROI or on the decrense V : so it ROI is the basis for evaluation, she will dectine V the investment. On the other hand, residual income positive , and win raise V overail residual income. If the division is evaluated on the basis of residual income, the project will be basis of residual income. Overall division ROI wills accepted Previous Check My Work

Explanation / Answer

ROI= Average income/investment in Assets. It is basically the percentage of income from assets invested.

1)

a) ROI of division if radio project is not undertaken = Budgeted income/ Operating Assets

= 875000/5125000

= .1707 or 17.07%

b) The radio project alone

= 640,000/40000000

= 0.16 or 16%

c) If the radio project is undertaken

Income= 875000+640000 = 1,515,000

Assets = 5125000 + 4000000 = 9,125,000;

So ROI= 1515000/9125000

=.1660 or 16.60%

2) Calculation of residual income

Residual income = Operating income - required income,

Required income = Assets invested*Required return

a) Residual income of division if radio project is not undertaken

= $875,000 - (5,125,000*12%)

=$260,000

b) The radio project alone

= $6, 40,000 - (4,000,000*12%)

= $ 160,000

c) If the radio project is undertaken

Income= 875000+640000 = 1,515,000

Assets = 5125000 + 4000000 = 9,125,000;

Residual income = $ 1515000 - (9125000*12%)

=$ 420,000

3) The return on investment will decrease if invested in radio project as ROI is more without the project, but since the required return is less than ROI from radio project the residual income will Increase if invested in the project.

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