Consider the following data for EveGreen, Inc., : Operating income $2,000,000 Av

Question

Consider the following data for EveGreen, Inc., :

Operating income

$2,000,000

Average invested assets

6,000,000

ROI

33.33%  

Assumed EveGreen, Inc. uses a hurdle rate of 10% compute the division’s residual income.

Required:

(1) If the performance of the division manager is evaluated based on the division ROI and the division manager acts in personal interest, will the division manager accept the proposed project?

(2) The division manager is considering a proposed project with 25% ROI. If the performance of the division manager is evaluated based on the residual income and the division manager acts in personal interest, will the division manager accept the proposed project?

Operating income

$2,000,000

Average invested assets

6,000,000

ROI

33.33%  

Explanation / Answer

residual income = Operating income - Investment*Hurdle rate

a)

RI = 2000000 - 6000000*10% = 1400000

1)

Yes, As ROI of 33% is greater than hurdle rate of 10%

2)

Operating income = 25%*6000000 = 1500000

RI = 1500000- 6000000*10% = 900000

Yes, Accept as Residual income is positive

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