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a.
Identify the project that would be chosen by Person F for investment, if Person F’s objective were to maximize the location’s
a.
Explanation of Solution
Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies. The formula for ROI is as follows:
The projects that are having ROI greater than or equal to 15% would be attractive to Person F and would improve the ROI of Person F’s location. Project A and B are having ROI of 16.2% and 15.0% respectively, which would be attractive to Person F to improve the ROI of the current location.
b.
Identify the project that would increase the value of Incorporation S.
b.
Explanation of Solution
Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies. The formula for ROI is as follows:
The projects that are having ROI above the minimum required return established for Incorporation S of 12% would increase the value of Incorporation S. Projects A, B, C, and D are likely to increase the value of Incorporation S. However, Project E would not be acceptable.
c.
Identify the project that would have a negative residual income.
c.
Explanation of Solution
Residual income: Residual income is the excess of income over the minimum acceptable return on average capital invested. The minimum
Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies. The formula for ROI is as follows:
Determine the residual income (loss) of each project.
| Project | Operating Income | Residual Income (loss) |
| A | ||
| B | ||
| C | ||
| D | ||
| E |
Table (1)
As per Table (1), Project E is having residual income (Loss) of ($12,000).
d.
Create two rankings for the projects in order of acceptability if Person F is evaluated (1) on ROI and (2) on residual income.
d.
Explanation of Solution
Residual income: Residual income is the excess of income over the minimum acceptable return on average capital invested. The minimum rate of return shows the opportunity cost of using the invested capital. The formula for residual income is as follows:
Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies. The formula for ROI is as follows:
Rank the projects in order of acceptability based (1) on ROI.
| Project | Required capital | ROI | Ranking |
| A | $200,000 | 16.2% | 1 |
| B | $400,000 | 15.0% | 2 |
| C | $300,000 | 14.0% | 3 |
| D | $200,000 | 13.0% | 4 |
| E | $600,000 | 10.0% | 5 |
Table (2)
On the basis of ROI, Project A and Project B would be acceptable by Person F because the ROI yields 16.2% and 15.0% respectively which is higher than the current ROI of 15%.
Rank the projects in order of acceptability based (2) on residual income.
| Project | Operating Income | Residual Income (loss) | Ranking |
| A | 2 | ||
| B | 1 | ||
| C | 3 | ||
| D | 4 | ||
| E | 5 |
Table (3)
On the basis of residual income, Project A and Project B would be acceptable because the residual income is $12,000 and $8,400 respectively which are higher than the residual income of other projects.
e.
Explain the components of ROI and explain the manner by which the combination of components of ROI is useful for evaluating the success of business processes within a firm
e.
Explanation of Solution
Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies. The components of Return on Investment (ROI) are shown in the equation given below:
Return on sales ratio evaluates the operating income that can be expected from one dollar of sales. This ratio is helpful to management because it indicates how much operating profit is being generated from each dollar of sales.
Capital turnover is a ratio that measures the amount of sales generated from each dollar of capital investment. Thus, it shows the relationship between the net sales and the average capital invested. This ratio is useful in evaluating how efficiently a company is utilizing the invested capital to generate sales dollars.
Thus, the combination of capital turnover and return on sales allows a company to assess the success of the investments that are used to generate sales, and the profitability of each dollar with respect to sales.
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Chapter 25 Solutions
Financial & Managerial Accounting
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