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 $725,000 with operating assets of $3,625,000. 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 12 percent. Round all numbers to two decimal places.

Required:

1. Compute the ROl of:

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:

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. Do you suppose that Leslie will decide to invest in the new radio? Why or why not?

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	725,000.00(A)	640,000.00(A)	1,365,000.00(A)
Operating Assets	3,625,000.00(B)	4,000,000.00(B)	7,625,000.00(B)
1) Return on Investment = Income/Operating Assets	20.00%(A/B)	16.00%(A/B)	17.90%(A/B)
Required Income @12% of Operating assets	435,000.00	480,000.00	915,000.00
2) Residual income = ROI- Required Income	290,000.00	160,000.00	450,000.00

3.

ROI is greater if project is not undertaken

RI is greater if project is not undertaken

Hence,

             Leslie should not be accept the project if she decides based on ROI

    Therefore,

                    Leslie should be accept the project if she decides based on RI