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A division currently earns a return on investment (ROI) of 20%. It is considering investing in a project which has a residual income (RI) of $1,000 at an imputed interest charge of 20%.
What is the effect on the division’s ROI if the project is undertaken?
A. Increase
B. Decrease
C. Remain the same
D. Not possible to tell from this informationSir answer in the kit has specified it in this way
I.e if division currently earns an ROI of 20%, this could be represented by operating profit of $20,000 and net assets of $100,000, that is clear to me
Then it says a residual income of $1000 could be represented by an operating profit of $11000, sir I can’t figure out where this 11,000 came from as well as well capital employed they are using is 50,000 when calculating for residual income
They’ve provided this logic, far quicker is to realise that a project offering a positive residual income at an imputed interest rate of 20% must be offering a return higher than 20% and therefore must improve the existing ROI of 20% which makes sense and i got that, but i still wanted to know how did they calculate R.I, where that 11000 operating profit and 50,000 c.e is coming from, could you please explain that sir
They invented the 50,000 etc just to illustrate the point they are making.
Oh but sir why wouldn’t we use the same figures as of roce? Like the profit 20,000 and capital employed 100,000, it’s not like residual income is negative that must’ve happened on different figures
If the profit was 20,000 and the capital employed was 100,000 then the residual income would be 0. The RI is 1,000 as per the question.
Don’t over complicate things 🙂
Haha sorry sir and i got it, i understood that logic but i always have this habit of thinking why didn’t we use that instead of that :’) thankyou so much for clearing my every query! ^-^
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