Question

Sicilian Defence, a division of Queen's Gambit Corp., has a net operating income of $60,000 and average operating assets of $300,000. The minimum required rate of return for the company is 15%. If the manager of the Sicilian Defence division is evaluated based on residual income, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?

Answer 1

Queen's Gambit Corp.

Sicilian Defence Division

If the manager of the Sicilian Defence division is evaluated based on residual income, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?

Yes.

The additional investment yields comparable positive Residual Income.

Step-by-step explanation:

a) Data and Calculations:

Net operating income of Sicilian Defence Division = $60,000

Average operating assets = $300,000

Required rate of return for the company = 15%

Residual income (RI)= Operating Income - (Operating Assets x Required Rate of Return)

= $60,000 - ($300,000 * 15%)

= $60,000 - $45,000

= $15,000

Investment cost = $100,000

Additional net operating income = $18,000

Residual Income = $18,000 - ($100,000 * 15%)

= $18,000 - $15,000

= $3,000

Total residual income = $78,000 - ($400,000 * 15%)

= $78,000 - $60,000

= $18,000