Chapter 15, Problem 24P

Comparing return on investment and residual income

The manager of the Cranston Division of Wynn Manufacturing Corporation is currently producing a 20 percent return on invested capital. Wynn’s desired rate of return is 16 percent. The Cranston Division has $6,000,000 of capital invested in operating assets and access to additional funds as needed. The manager is considering a new investment in operating assets that will require a $1,500,000 capital commitment and promises an 18 percent return.

Required

1. a. Would it be advantageous for Wynn Manufacturing Corporation if the Cranston Division makes the investment under consideration?
2. b. What effect would the proposed investment have on the Cranston Division’s return on investment? Show computations.
3. c. What effect would the proposed investment have on the Cranston Division’s residual income? Show computations.
4. d. Would return on investment or residual income be the better performance measure for the Cranston Division’s manager? Explain.