Question

Sunnyvale Inc. is considering investing in a new project. The average invested assets of the project would be $450,000 and the incremental operating income would be $37,000. The company currently generates operating income of $220,000 and the invested assets are $2,005,000. The required rate of return (hurdle rate) is 5% on new projects.

Required:
a. What is the ROI before investing in the project?
b. What is the residual income before investing in the project?
c. What is the after investing in the project? (Round your answer to 2 decimal places.)
d. What is the residual income after investing in the project?

Answer 1

Rate of Interest = Operating Income/Average Invested Asset

Residual Income = (Operating Income- Average Invested Assets)*Minimum Required rate of return

a. ROI before investing = $220,000/$2,005,000

ROI before investing = 0.109725686

ROI before investing = 10.97%

b. Residual Income = $220,000 - $2,005,000*5%

Residual Income = $220,000 - $100,250

Residual Income = $119,750

c. ROI after investing = ($220,000+$37,000) / ($2,005,000+$450,000)

ROI after investing = $257,000/$2,455,000

ROI after investing = 0.10468432

ROI after investing = 10.47%

d. Residual Income after investing = $220,000 + $37,000

Residual Income after investing = $257,000