Question

1. Identify the four types and provide a unique example (one not in the slides/study guide) of each.
   
2. For the upcoming year, Dorby, Inc. (which has an 8% required return) is expected to produce $10,000 operating income on $100,000 of invested assets by opening its flagship store. Dorby is considering expanding to a second location, which would require an additional $100,000 investment but would produce $9,000 additional operating income.
   • What is the increase/decrease in return on investment (ROI) if the second location is opened?
   • What is the increase/decrease in residual income (RI) if the second location is opened?
   • Why did the two measures go in opposite directions?
   • Should the second store be opened?

Answer 1

	Store 1	Store 2	Total
Investment	100,000	100,000	200,000
Operating Income	10,000	9,000	19,000
Return on Investment (Operating income / Investment)	10.00%	9.00%	9.50%
Required Return	8%	8%	8%
Toal income as per required return	8,000	8,000	16,000
Residual Income (Operating Income - Required income)	2,000	1,000	3,000

There is 0.50% decreasedecrease in return on investment (ROI) if the second location is opened.

Before opening = 10%

After Opening = 9.5%

Decrease = 0.50%

$1,000 increase in residual income (RI) if the second location is opened.

Before opening = $2,000

After Opening = $3,000

Increase = $1,000

Two measure are opposite as method of calculation is diffrent. ROI will calculate on % basis , while Residual income calculate on total amount.

Yes, Second Store should be open as it gives higher return compare to required return.