Question

Assuming that there are no income taxes, what would be the ROI and residual income, respectively, for this equipment, which has an average value of US $100,000?

Answer 1

Please see complete question below :

CPA-08299: Managers of the Doggie Food Co. want to add a bonus component to their compensation plan. They are trying to decide between return on investment (ROI) and residual income (RI) as the performance measure they will use. If Doggie adopts the RI performance measure, the relevant required rate of return would be 18%. One segment of Doggie is the Good Treats division, where the manager has invested in new equipment. The operating results from this equipment are as follows:

Revenues $ 80,000

Cost of goods sold 45,000

General and administrative expenses 15,000

Assuming that there are no income taxes, what would be the ROI and RI for this equipment that has an average value of $100,000?

ROI RI

Answer:

ROI =  20% and RI = $2000

Explanation:

Return On Investment(ROI) = Profit before Interest & Tax/Average Investment

Profit before Interest & Tax (PBIT) = Revenue -cost of goods sold- General & Adm expenses

PBIT= $ 80,000 - $45,000 -$15,000

      = $20,000

ROI = ($20,000/100,000) * 100% = 20%

Residual Income = PBIT - (Average Investment* Required Rate of Return)

                            =$20,000- (18%* 100,000)

                           =$20,000- $18,000

                           = $2000