Question

you must prepare a return on investment analysis for the regional manager of Fast & Great Burgers. This growing chain is trying to decide which outlet of two alternatives to open. The first location (A) requires a $500,000 investment and is expected to yield annual net income of $70,000. The second location (B) requires a $200,000 investment and is expected to yield annual net income of $44,000. Compute the return on investment for each Fast & Great Burgers alternative. Using return on investment as your only criterion, which location (A or B) should the company open? (The chain currently generates an 22% return on total assets.)

Required information

[The following information applies to the questions displayed below.]

Megamart, a retailer of consumer goods, provides the following information on two of its departments (each considered an investment center).

Investment Center	Sales			Income			Average Invested Assets
Electronics	$	40,800,000		$	3,060,000		$	17,000,000
Sporting goods		17,680,000			2,210,000			13,000,000

1. Compute return on investment for each department. Using return on investment, which department is most efficient at using assets to generate returns for the company?
2. Assume a target income level of 11% of average invested assets. Compute residual income for each department. Which department generated the most residual income for the company?
3. Assume the Electronics department is presented with a new investment opportunity that will yield a 15% return on investment. Should the new investment opportunity be accepted?

Answer 1

Solution 1:

Return on investment
Particulars	Choose Numerator	/	Choose denominator	=	Return on Investment
Formula	Net Income	/	Average Invested Assets	=	Return on Investment
Electronics	$3,060,000.00	/	$17,000,000.00	=	18.00%
Sporting goods	$2,210,000.00	/	$13,000,000.00	=	17.00%
Which department is more efficient at using assets to generate returns for the company					Electronics

Solution 2:

Computation of Residual Income
Investment Center	Electronics	Sporting Goods
Net Income	$3,060,000.00	$2,210,000.00
Target Net Income	$1,870,000.00	$1,430,000.00
Residual Income	$1,190,000.00	$780,000.00
Which department generated the most residual income for the company		Electronics

solution 3:

If performance is measured using ROI, then new investment opportunity should not be accepted as it will decrease overall ROI of the division. If performance is measured using residual income then new investment opportunity should be accepted as ROI offered by new investment opportunity is higher than minimum required return.