RETURN ON INVESTMENT AND RESIDUAL INCOME (PLEASE ANSWER PART C) PART A: Comedy C

ID: 2753473 • Letter: R

Question

RETURN ON INVESTMENT AND RESIDUAL INCOME (PLEASE ANSWER PART C)

PART A: Comedy Corporation has two divisions, Abbott and Costello. Abbott has $3.0 million in operating assets, and net operating income of $480,000, while Costello has $2.0 million in opearting assets and has net operating income of $180,000. Each division is required to earn a minimum of 8.5% on its investment in operating assets. Comedy's cost of capital is also 8.5%.

Based on this information, determine the Abott and Costello's current return on investment (ROI). Which division is "better" based on this analysis? Use the template to answer this questions, please show your work and provide a well-written paragraph explaining what your numbers mean.

Answer to Part A:

The better investment is Abbott (16% ROI) against 9% ROI of Costella.

PART B: Using the same information as above, if the Abbott division has an opportunity to make an investment of $1,750,000 that would generate 14.3% return on invested assets (i.e., $250,000 per year), is this investment beneficial for the Abbott Division using ROI analysis? What about the Comedy Corporation using ROI analysis? Why or why not? Use the templave below to answer this question. Please show your work and provide a well-written paragraph explaining what your numbers mean.

Answer to Part B:

If Abbot accepts the new investment, its overall ROI will be reduced from 16 to 15.4. Therefore, the investment is not beneficial for the divsion.

For Comedy the investment is beneficial because the ROI of the investment is more than its cost of capital and if i is accepted it will incrase returns to the corporation's shareholders.

***Please answer:****

PART C: Using the same information as above, perform and invesment analysis using the residual income method. If you were the manager of the Abbot division, which method would you choose? Would your answer be different if you were the manager of Comedy Corporation? Why or why not? Use the template below to answer this question. Provide a well-written paragraph, explaining what your numbers mean.

Part A Abbott Costella Overall Average Operating Assets 3000000 2000000 5000000 Net Operating income 480000 180000 660000 Return on Investment 16 9 13.2

Explanation / Answer

Solution :

Part C

Abbot (Present)

New Project

Overall

Average Operating Assets

3000000

1750000

4750000

Net Operaing Income (A)

480000

250000

730000

Minimum Required Return:

8.5% x Avg. Oper. Assets (B)

255000

148750

403750

Residual Income = (A) minus (B)

225000

101250

326250