PERFORMANCE EVALUATION OF INVESTMENT CENTERS

Viola Holloway is the division manager of the Instruments Division of Forrow Aerodynamic Company. Viola Holloway is evaluating whether to acquire a new product for the Instruments Division. The Budgeted Income (Net Operating Income) for next year for the Instruments Division is presently $750,000 with Average Operating Assets of $3,000,000. The proposed investment in the new product would add projected Net Income (Net Operating Income) of $360,000 and would require an additional investment in Equipment (Average Operating Assets) of $2,000,000. Forrow Aerodynamic Company requires a Minimum Required Rate Of Return on its investment of twelve percent (12%).

Required

Compute the Return On Investment (ROI) for the Instruments Division of Forrow Aerodynamic Company under the following scenarios:

a. If the new product is not acquired.

b. Of the new product only (assuming it is acquired).

c. If the new product is acquired.

Compute the Residual Income for the Instruments Division of Forrow Aerodynamic Company under the following scenarios:

a. If the new product is not acquired.

b. Of the new product only (assuming it is acquired).

c. If the new product is acquired.

Will Viola Holloway acquire or not acquire the new product if Forrow Aerodynamic Company evaluates performance of its Investments Centers under the:

Return On Investment (ROI) Formula.

Residual Income Approach.

.

	1.					Net Operating Income	/	Average Operating Assets	=	ROI
			a.		ROI of Division without New Product	$		$		%
			b.		ROI of New Product	$		$		%
			c.		ROI of Division with New Product	$		$		%
	2.					Net Operating Income	(	Minimum Rate of Return		Average Operating Assets	) =	Residual Income
			a.		Residual Income without New Product	$		%		$		$
			b.		Residual Income of New Product	$		%		$		$
			c.		Residual Income with New Product	$		%		$		$
3.