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Please help me to get the correct answer:
A division of a company has capital employed of $2m and its return on capital is 12%. It is considering a new project requiring capital of $500000 and is expected to yield profits $90000 per annum. The company’s interest rate is 10%,
If the new project is accepted, what will the residual income of the division be?
RI = Controllable profit – imputed interest charge on traceable investment
= $90000 – {10/100 * 500000}
=$ 40000While the correct answer is $80,000.
You have only calculated the RI of the new investment, but the question asks for the RI of the division!
The division is already making profits of 12% x $2M = 240,000. Therefore the new profit will be 240,000 + 90,000 = 330,000.
The division already has capital of $2M and therefore the new capital will be $2,500,000
Therefore the RI of the division is 330,000 – (10% x 2,500,000) = 80,000
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