Question

Assume Rooney Modems, Inc., is a division of Gilmore Business Products (GBP). GBP uses ROI as the primary measure of managerial performance. GBP has a desired return on investment (ROI) of 5.90 percent. The company has $230,000 of investment funds to be assigned to its divisions. The president of Rooney is aware of an investment opportunity for these funds that is expected to yield an ROI of 6.50 percent. Income Statement Sales revenue Cost of goods sold Gross margin Sales commission Depreciation expense Administrative expense Net income $ 730,000 (520,000 $ 210,000 (43,000) (15,000) 74,550) $ 77,450

Answer 1

Answer a1
	Net income	$            77,450
Add:	Depreciation expense	$            15,000
	net cash inflow	$            92,450
Divided by:	Net investment (= Total assets)	$      1,097,450
	Existing Return on Investment (ROI)	8.42%
Answer a2
	Desired return on investment	5.90%
	Existing Return on Investment (ROI)	8.42%
	Existing ROI is greater than the required rate of return, therefore President of Gibson rejects the investment opportunity.	Reject
Answer c1
	Operating income (230000*6.5%)	$            14,950
Less:	Minimum required return (230000*5.9%)	$            13,570
	Residual Income	$               1,380
Answer c2
	Residual Income is positive. therefore President of Gibson accepts the investment opportunity.	Accept