Question

The manager of stock division projects the following for next year: sales $185,000 operating income $60,000 operating assets $375,000 the manager can invest in an additional project that would require $40,000 investment in additional assets and would generate $6,000 of additional income. the company's minimum rate of return is 14%. which of the following statements is true? select one: a. average investment for stock division will decrease if the project is accepted for investment. b. if the manager invests in the additional project, roi of the division will decrease. c. the residual income of the project is less than the residual income of the division without the project; therefore the project will be rejected. d. none of these. e. if the manager invests in the additional project, residual income of the division will increase.

Answer 1

Answer:

e. Is right, since residual income will rise from $7,500 to $7,900

Explanation:

The computation of given question is shown below:-

1. Current return on investment of division = $60,000 ÷ $375000 × 100

= 16%

2. Return on investment on new project = $6000 ÷ $40,000 × 100

= 15%

3. The average return on investment = ($60,000 + 6,000) ÷ ($375,000 + 40,000)

= 15.9%

4. The residual income without new project = $60,000 - ($375,000 × 14%)

= $7,500

5. The residual income with new project = $66,000 - (($375,000 + $40,000) × 14%))

= $7,900

Now we will analyze every points which is here below:-

a. It's incorrect as the average investment will go from $3,75,000 to $4,15,000

b. is incorrect, as the division's ROI will fall from 16% to 15.9%

c. This is incorrect as the residual income will increase from $7,500 to $7,900

e. Is right, since residual income will rise from $7,500 to $7,900