Question

1. + -/3.33 points Question 1 (performance evaluation: RI, ROI) Generic Motors Corporation has two divisions, Kadillack and Chevrolay. Their performance for last year is as follows. Kadillack Chevrolay Investment (operating assets) $300 million $1,200 million Profit $57 million $174 million The required rate of return (cost of capital) for Generic Motors is 10% a year. Required: a) What is the return on investment (ROI) for each division? Kadillack ROI = % (enter say 9.5% as 9.5, not as 0.095 and not as 9.5%) Chevrolay ROI = Which division performs better, based on ROI? (1=Kadillack, 2=Chevrolay) % b) What is the residual income (RI) for each division? Kadillack RI = $ million (enter say $3.52 million as 3.52, not as 3,520,000) Chevrolay RI = $ million Which division performs better, based on RI? (1=Kadillack, 2=Chevrolay) c) Which of the two measures (ROI or RI) would you use to decide which division performs better? (1=ROI, 2=RI)

Answer 1

a)Return on Investment = Net Profit / Total Investment x 100

Kadillack

Net Profit= 57 Million (Given)

Total Investment = 300 Million (Given)

Return on Investment = 57 / 300 x 100 = 19

Chevrolay

Net Profit= 174 Million (Given)

Total Investment = 1200 Million (Given)

Return on Investment = 174 / 1200 x 100 = 14.5

Based on Return on Investment Kadillack will be selected because it has higher Return on Investment

b)Residual Income = Net Operating Income - (Minimum required rate if return x Cost of Investment)

Kadillack

Net Operating Income = 57 Million

Minimum required rate if return = 10%

Cost of Investment = 300 Million

Residual Income = 57 - ( 10% x 300 )

=57 -30 = 27 Million

Chevrolay

Net Operating Income = 174 Million

Minimum required rate if return = 10%

Cost of Investment = 1200 Million

Residual Income = 174 - ( 10% x 1200 )

=174 - 120 = 54 Million

Based on Residual Income Chevrolay will be selected because it has Residual Income.

c)Residual Income measure is better than return on investment because Residual Income is absolute measure