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8 November, 17:27

Gable Ceramics, a division of Alderman Corporation, has an operating income of $ 64 comma 000 and total assets of $ 400 comma 000. The required rate of return for the company is 11 %. The company is evaluating whether it should use return on investment (ROI) or residual income (RI) as a measurement of performance for its division managers. The manager of Gable Ceramics has the opportunity to undertake a new project that will require an investment of $ 100 comma 000. This investment would earn $ 14 comma 000 for the company.

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  1. 8 November, 17:47
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    The question is meant to compare the original ROI and RI before the investment compared to the new investment is ROI and RI

    The new investment has a lower return on investment of 11% compared to original 14%

    However, the project should be considered since it has $3000 residual income in additional to the original residual income

    Explanation:

    The return on investment and residual income before the new investment are computed thus:

    return on investment=operating income/total assets=$64,000/$400,000=16%

    residual income=operating income - (total assets*rate of return)

    =$64,000 - ($400,000*11%) = $20,000

    Thereafter, the return on investment and residual income on the new investment are computed thus:

    return on investment=operating income/total assets=$14,000/$100,000=14%

    residual income=operating income - (total assets*rate of return)

    =$14,000 - ($100,000*11%) = $3,000
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