Comparing return on investment and residual income
The manager of the Cohen Division of Leland Manufacturing Corporation is currently producing a 20 percent return on invested capital. Leland’s desired rate of return is 16 percent. The Cohen Division has $12,000,000 of capital invested in operating assets and access to additional funds as needed. The manager is considering a new investment in operating assets that will require a $3,000,000 capital commitment and promises an 18 percent return.
Required
a. Would it be advantageous for Leland Manufacturing Corporation if the Cohen Division makes the investment under consideration?
b. What effect would the proposed investment have on the Cohen Division’s return on investment? Show computations.
c. What effect would the proposed investment have on the Cohen Division’s residual income? Show computations.
d. Would return on investment or residual income be the better performance measure for the Cohen Division’s manager? Explain.
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