Question

The Clipper Corporation had net operating income of $380,000 and average operating assets of $2,000,000. The corporation requires a return on investment of 18%. A division of Clipper Corporation is considering an investment of $70,000 in a project that will generate annual net operating income of $12,950. If the division currently has a return on investment of 20% and its manager is evaluated based on the division calculate the company's return on investment (ROI) and residual income (RI).

Answer 1

Company's return on investment (ROI) = Net operating income / Average operating assets

Company's return on investment (ROI) = 380000/2000000

Company's return on investment (ROI) = 19%

Residual income = Net operating income - Return on investment*Average operating assets

Residual income = 380000 - 18%*2000000

Residual income = $20,000

ROI of new investment = Net operating income/Investment

ROI of new investment = 12950/70000

ROI of new investment = 18.50%

ROI of overall company if investment taken place = Total net operating income/ Total average operating assets

ROI of overall company if investment taken place = (380000+12950) / (2000000+70000)

ROI of overall company if investment taken place = 18.98%.