Question

The Western Division of Claremont Company had net operating income of $142,000 and average invested assets of $551,000. Claremont has a required rate of return of 13.00 percent. Western has an opportunity to increase operating income by $51,000 with a $98,000 investment in assets. Compute Western Division's return on investment and residual income currently and if it undertakes the project. (Enter your ROI answers as a percentage rounded to two decimal places, (i.e., 0.1234 should be entered as 12.34%). Round your Residual Income (Loss) answers to the nearest whole dollar.) Currently: Return on Investment (ROI) Residual Income (Loss) Proposed Project: Return on Investment (ROI) % Residual Income (Loss)

Answer 1

Return on investment (ROI) before undertaking project.

Given information,

Net Operating Income = $ 142000

Average Invested Assets = $ 551000

Return on investment = Net operating revenue/ Investment * 100

= $142000/ $ 551000 *100

= 25.77%

Residual Income = Net operating Income - ( Operating Assets * Cost of Capital)

= $ 142000 - ($ 551000 * 13/100)

= $ 142000 - $ 71630

= $ 70370

Hence Return on investment = 25.77%

Residual Income = $ 70370

Calculation of return on investment and Residual income after undertaking project.

Revised Net Operating Income = $ 142000 + $ 51000

= $ 193000

Revised Invested Assets = $ 551000+ $ 98000

= $ 649000

Revised Return on Investment = Revised Net Operating Income/ Revised Invested Assets *100

= $ 193000 / $ 649000 *100

= 29.74%

Revised Residual Income = (Revised Net Operating Income - (Revised Operating Assets * Cost of Capital)

= $ 193000 - ( $ 649000 * 13/100)

= $ 193000 - $ 84370

= $ 108630

Hence Revised Return on Investment is 29.74% and

Revised Residual Income is $ 108630