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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773

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BuyFindarrow_forward

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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Return on Investment and Investment Decisions

Leslie Blandings, division manager of Audiotech Inc., was debating the merits of a new product—a weather radio that would put out a warning if the county in which the listener lived were under a severe thunderstorm or tornado alert.

The budgeted income of the division was $725,000 with operating assets of $3,625,000. The proposed investment would add income of $640,000 and would require an additional investment in equipment of $4,000,000. The minimum required return on investment for the company is 12%. Round all numbers to two decimal places.

Required:

  1. 1. Compute the ROI of the:
    1. a. division if the radio project is not undertaken.
    2. b. radio project alone.
    3. c. division if the radio project is undertaken.
  2. 2. Compute the residual income of the:
    1. a. division if the radio project is not undertaken.
    2. b. radio project alone.
    3. c. division if the radio project is undertaken.
  3. 3. CONCEPTUAL CONNECTION Do you suppose that Leslie will decide to invest in the new radio? Why or why not?

1.

To determine

Compute ROI.

Explanation

a.

Return on Investment (ROI):

Return on investment can be defined as the amount of profit earned by the company on per dollar of investment. It can be computed by dividing operating income by the average operating assets.

Use the following formula to calculate the ROI of the division if the project is not considered:

ROI=Operating IncomeAverage operating assets

Substitute $725,000 for operating income and $3,625,000 for average operating assets in the above formula.

ROI=$725,000$3,625,000=0.20

Therefore, the percentage of ROI is 0.20 or 20%.

b.

Use the following formula to calculate the ROI of the radio project:

ROI=Operating IncomeAverage operating assets

Substitute $640,000 for operating income and $4,000,000 for average operating assets in the above formula.

ROI=$640,000$4,000,000=0.16

Therefore, the percentage of ROI is 0.16 or 16%.

c.

Use the following formula to calculate the ROI of the division if the project is considered:

ROI=Operating Income1Average operating assets2

Substitute $1,365,000 for operating income and $7,625,000 for average operating assets in the above formula

2.

To determine

Compute residual income.

3.

To determine

Describe whether Person L should invest in the new radio.

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