Question

The Monarch Division of Allgood Corporation has a current ROI of 11 percent. The company's target ROI is 7 percent. The Monarch Division has an opportunity to invest $4,500,000 at 9 percent but is reluctant to do so because its ROI will fall to 10.25 percent. The present investment base for the division is $7,500,000. Required a. Calculate the current residual income and the residual income with the new investment opportunity being included. b. Based on your answers to requirement a, should Mơnarch Division make the investment?

Answer 1

a. The current residual income is $825,000 and the residual income with the new investment opportunity is $975,000. b. The Monarch Division should make the investment as it will increase their residual income.

Step-by-step explanation:

a. The current residual income can be calculated by multiplying the current ROI by the Monarch Division's investment base:
Residual income = Current ROI * Investment base
Residual income = 11%× $7,500,000
Residual income = $825,000
The residual income with the new investment opportunity can be calculated by multiplying the new ROI with the sum of the investment base and the new investment:
Residual income with new investment = New ROI × (Investment base + New investment)
Residual income with new investment = 10.25% × ($7,500,000 + $4,500,000)
Residual income with new investment = $975,000

b. Based on the answers to requirement a, the Monarch Division should make the investment. The new investment opportunity will increase their residual income from $825,000 to $975,000, which is higher than the target ROI of 7%. Therefore, the investment is beneficial for the division.