Question

Return on Investment and Investment Decisions

Leslie Blandings, division manager of Audiotech Inc., was debating the merits of a new product—a weather radio that would put out a warning if the county in which the listener lived were under a severe thunderstorm or tornado alert.

The budgeted income of the division was $975,000 with operating assets of $5,125,000. The proposed investment would add income of $640,000 and would require an additional investment in equipment of $4,000,000. The minimum required return on investment for the company is 15%.

Required:

1. Compute the ROI of the following (round to the nearest whole percent):

a. The division if the radio project is not undertaken.	%
b. The radio project alone.	%
c. The division if the radio project is undertaken.	%

2. Compute the residual income of the following:

a. The division if the radio project is not undertaken.	$
b. The radio project alone.	$
c. The division if the radio project is undertaken.	$

3. (Fill in Blank) This depends on whether Leslie’s division is evaluated on the basis of ROI or on the basis of residual income. Overall division ROI wills________; so if ROI is the basis for evaluation, she will______ the investment. On the other hand, residual income for the project is________and will_________overall residual income. If the division is evaluated on the basis of residual income, the project will be _________

Answer 1

Statement showing computations
Particulars	a. The division if the radio project is not undertaken.	b. The radio project alone.	c. The division if the radio project is undertaken.
Budgeted Income	975,000.00	640,000.00	1,615,000.00
Operating Assets	5,125,000.00	4,000,000.00	9,125,000.00
1) Return on Investment = Income/Operating Assets	19.02%	16.00%	17.70%
Required Income @15% of Operating assets	435,000.00	600,000.00	1,368,750
2) Residual income = ROI- Reqd Income	206,250	40,000	246,250

3) Ans: The return on investment will decrease if invested in radio project as ROI is more without the project, but since the required return is less than ROI from radio project the residual income will Increase if invested in the project.