Question

ROI and Residual Income:
Impact of a New Investment
The Mustang Division of Detroit Motors had an operating income of $700,000 and net assets of $4,000,000. Detroit Motors has a target rate of return of 16 percent.

(a) Compute the return on investment. (Round your answer to three decimal places.)

(b) Compute the residual income.

(c) The Mustang Division has an opportunity to increase operating income by $200,000 with an $950,000 investment in assets.

1. Compute the Mustang Division's return on investment if the project is undertaken. (Round your answer to three decimal places.)

2. Compute the Mustang Division's residual income if the project is undertaken.

Answer 1

a
Operating income	700000
Divide by Net assets	4000000
Return on investment	17.50%
b
Operating income	700000
Less: Required return	640000	=4000000*16%
Residual income	60000
c
1
Operating income	900000	=700000+200000
Divide by Net assets	4950000	=4000000+950000
Return on investment	18.182%
2
Operating income	900000	=700000+200000
Less: Required return	792000	=4950000*16%
Residual income	108000