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 11 percent. The company target ROI is 7 percent. The Monarch Division has an opportunity to invest $4,900,000 at 9 percent but is reluctant to do so because its ROI will fall to 10.30 percent. The present investment base for the division is $9,100,000. Required a. Calculate the current residual income and the residual income with the new investment opportunity being included. b. Based on your answers to requirement a, should Monarch Division make the investment? Current residual income New residual income b. Should Monarch Division make the investment?

Answer 1

a) Computation of current resideal income current Rol = lo ve love present anvestment - $ 91,00,000 Operating ancome & $91,000,000 X 117. D E $1001000 Target Rol = 7. Target operating encome a $9100.000X7.). = $637000 current residual income = actual operating ancome - Target operating = $ 1001000 – $637000 v 2 $ 366000 ancome New residual ancome in ERP New Rol - 103 fra Total anvestment = $9200,000 + & ugooooo ,40,00,000 operating ancome = $1,40.00,000, X10:351 3. $ 14; 42.000 Target ROI – 7.l. Target operating in couse - $ 140,00,000 X+] - $ 980,000 New residual ancome = $14,42000-$980000 = $4462000

b) yes monarch dinision can make the anvestment since it's residual income is more than older resideal ancourse i.e alter anvestment residual ancome more that before investment resideal ancouse. $364000 a Current residual income New residual income $ 4462000 yes should monarch division make the anvestment