Question

Campbell Home Maintenance Company earned operating income of $6,821,100 on operating assets of $58,300,000 during Year 2. The Tree Cutting Division earned $1,174,670 on operating assets of $6,790,000. Campbell has offered the Tree Cutting Division $2,170,000 of additional operating assets. The manager of the Tree Cutting Division believes he could use the additional assets to generate operating income amounting to $434,000. Campbell has a desired return on investment (ROI) of 9.70 percent. Required Calculate the return on investment for Campbell, the Tree Cutting Division, and the additional investment opportunity. Calculate the residual income for Campbell, the Tree Cutting Division, and the additional investment opportunity.

Answer 1

1.

Return on investment = operating income divided by operating Assets

A. Return on investment on Campbell business = $6,821,100 / $58,300,000 x 100%

= 11.7%

B. Return on investment on Tree cutting business = $1,174,670 / $6,790,000 x 100%

= 17.3%

C. Return on new investment on tree cutting business :

i. Only new investment = $434,000 / $2,170,000 x 100%

= 20%

ii. Total new investment = $1,608,670 / $8,960,000

= 18%

2.

Residual income = controllable Margin - (required return % x average operating assets)

Residual income on Campbell business = $6,821,100 - (9.70% x $58,300,000)

= $1,166,000

B. Residual income on Tree cutting business = $1,174,670 - (9.70% x $6,790,000)

= $516,040

C. Residual income on tree cutting business :

i. Only new investment = $434,000 - (9.70% x $2,170,000)

= $223,510

ii. Total new investment = $1,608,670 - (9.70% x $8,960,000)

= $739,550