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Lumberton Home Maintenance Company (LHMC) earned operating income of $6,000,000 on operating assets of $62,500,000 during...

Lumberton Home Maintenance Company (LHMC) earned operating income of $6,000,000 on operating assets of $62,500,000 during 2018. The Tree Cutting Division earned $1,000,000 on operating assets of $10,000,000. LHMC has offered the Tree Cutting Division $1,250,000 of additional operating assets. The manager of the Tree Cutting Division believes he could use the additional assets to generate operating income amounting to $112,500. LHMC has a desired return on investment (ROI) of 8 percent.

Required

Calculate the return on investment for LHMC, the Tree Cutting Division, and the additional investment opportunity.

Calculate the residual income for LHMC, the Tree Cutting Division, and the additional investment opportunity

Solutions

Expert Solution

1)
Return on investment = net operating income / net operating assets
LHMC:
net operating income = $6000000
net operating assets = $62500000
Return on investment = $6000000/$62500000 = 9.6%
Tree Cutting Division:
net operating income = $1000000
net operating assets = $10000000
Return on investment = $1000000/$10000000 = 10%
additional investment opportunity:
net operating income = $112500
net operating assets = $1250000
Return on investment = $1000000/$10000000 = 9%
2)
Residual income = net operating income - (Minimum required return on assets*Average operating assets of the department)
LHMC:
net operating income = $6000000
net operating assets = $62500000
Minimum required return on assets = 8%
Residual income = $6000000-(8%*62500000) = $1000000
Tree Cutting Division:
net operating income = $1000000
net operating assets = $10000000
Minimum required return on assets = 8%
Residual income = $1000000-(8%*10000000) = $200000
additional investment opportunity:
net operating income = $112500
net operating assets = $1250000
Minimum required return on assets = 8%
Residual income = $112500-(8%*1250000) = $12500

ekkarill92 answered 1 year ago
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