Return on Investment and Investment Decisions

Leslie Blandings, division manager of Audiotech Inc., was debating the merits of a new producta 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 $975,000 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%.

Required:

1. Compute the ROI of the following (round to the nearest whole percent):

a. The division if the radio project is not undertaken.
b. The radio project alone.
c. The division if the radio project is undertaken.

2. Compute the residual income of the following:

a. The division if the radio project is not undertaken.
b. The radio project alone.
c. The division if the radio project is undertaken.

3. This depends on whether Leslies division is evaluated on the basis of ROI or on the basis of residual income. Overall division ROI wills decrease ; so if ROI is the basis for evaluation, she will decline the investment. On the other hand, residual income for the project is positive and will raise overall residual income. If the division is evaluated on the basis of residual income, the project will be accepted