The office product division in Hulk Company reported $11,250 net operating income with $75,000 average operating...

The office product division in Hulk Company reported $11,250 net operating income with $75,000 average operating assets this year. The office product division has a new investment opportunity that would increase net operating income by $4,375 with $35,000 additional investment.

(Q) Which of the following statements is TRUE given that the company's minimum required rate of return is 10%?

If the division is evaluated on the basis of Residual income, the manager of the office product division would accept the new investment because it is good for the division.
If the division is evaluated on the basis of ROI, the manager of the office product division would accept the new investment because it is good for the division.
If the division is evaluated on the basis of ROI, the manager of the office product division would not accept the new investment because it is bad for the company.
If the division is evaluated on the basis of Residual income, the manager of the office product division would not accept the new investment because it is bad for the company.
Regardless of whether the division is evaluated on the basis of ROI or Residual income, the manager will not accept the new investment because it is bad for the company.

Solutions

Expert Solution

ROI = Net operating income/Average operating assets

Current ROI for Office Product Division = $11,250/$75,000 = 15%

ROI of new investment = $4,375/$35,000 = 12.5%

Residual income (RI) = Net operating income – (Minimum required rate of return x Investment)

Current RI for Office Product Division = $11,250 – (10% x $75,000) = $11,250 - $7,500 = $3,750

RI of new investment = $4,375 – (10% x $35,000) = $4,375 - $3,500 = $875

If the division is evaluated on the basis of Residual income, the manager of the office product division would accept the new investment because it is good for the division – TRUE. Since the new investment would increase the RI of the division by $875.

If the division is evaluated on the basis of ROI, the manager of the office product division would accept the new investment because it is good for the division – FALSE. The manager would not accept the new investment since it has a ROI of 12.5% which is lower than the division’s current ROI of 15%.

If the division is evaluated on the basis of ROI, the manager of the office product division would not accept the new investment because it is bad for the company – FALSE. The new investment is not bad for the company since it has a ROI of 12.5% which is higher than the company’s minimum required rate of return of 10%.

If the division is evaluated on the basis of Residual income, the manager of the office product division would not accept the new investment because it is bad for the company FALSE. The new investment has Residual income of $875 and hence it is not bad for the company.

Regardless of whether the division is evaluated on the basis of ROI or Residual income, the manager will not accept the new investment because it is bad for the company FALSE. The new investment is good for the company whether it is evaluated on the basis of ROI or Residual income.

Thus, the answer is:

If the division is evaluated on the basis of Residual income, the manager of the office product division would accept the new investment because it is good for the division.

ekkarill92 answered 1 year ago

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