Question

1. A residual income of $0 would indicate that a division’s ROI was the same as the minimum required rate of return for the division.

1. True            b. False

       2.   ROI used alone as a performance measure encourages managers to accept all investment decisions that will benefit the company as a whole.

              a. True                 b. False

Questions 3-5 refer to the following:

The Upholstery Division at Robinson’s Furniture recorded operating data as follows for the past year:

Sales                                                    $400,000

Gross margin                                            80,000

Net operating income                               50,000

Stockholders’ equity                                 90,000

Average operating assets                        200,000

The minimum required rate of return                    14%

3. For the past year, the return on investment was:

a. 5%                 c. 30%

b. 15%                 d. 25%

4. The residual income for the Upholstery Division would be:

a. $6,000            c. $22,000

b. $12,000           d. unknown given the limited data available.

5. Assume that the Upholstery Division has the opportunity to invest in a project that will cost $70,000 and will yield an annual net income of $14,000. Which of the two measures—ROI or Residual Income—would be increased if Jenkins made this investment?

a. only ROI would increase

b. only Residual Income would increase

c. both ROI and Residual Income would increase

d. neither ROI nor Residual Income would increase

Answer 1

Answer-1:

a. True

Answer-2:

b. False

Answer-3:

Return on investment = Net operating income / Average operating assets × 100

                                   =$50,000 / $200,000 × 100 = 25%

Correct answer is option (d)

Answer-4:

Residual Income = Net operating income - Minimum Required Rate of Return × Average Operating Assets

                             = $50,000 - (14% × $200,000) = $50,000 - $28,000 = $22,000

Correct answer is option (c)