ROI and Residual Income
Response to the following problem:
Pacific Corporation has a number of autonomous divisions. Its real estate division has recently reviewed a number of investment proposals
a. A new office building would cost $450,000 and would generate yearly operating profit of $80,000.
b. A computer system would cost $350,000 and would reduce bookkeeping and clerical costs by $50,000 annually.
c. A new apartment house would cost $900,000 and would generate yearly operating profit of $150,000.
The real estate division currently has total assets of $1.8 million and operating profit of $350,000.
Required:
1. Assuming that the performance of the manager of the real estate division is evaluated on the basis of the division's ROI, evaluate each of the independent proposals, and determine whether it should be accepted or rejected.
2. Assuming that the manager's performance is evaluated on a residual income basis, determine whether each of the proposals should be accepted or rejected. (The division's minimum accepted rate of return is 15%.)