Calculate the existing ROI for Magnificent a2 Based on your

Calculate the existing ROI for Magnificent.

a-2. Based on your computations will the President of Magnificent accept or reject the $300,000 investment opportunity?

c-1. Calculate the estimated residual income of the new investment opportunity.

Assume Magnificent Modems, Inc., is a division of Gilmore Business Products (GBP). GBP uses ROl as the primary measure of managerial performance. GBP has a desired return on investment (ROI) of 6.60 percent. The company has $300,000 of investment funds to be assigned to its divisions. The president of Magnificent is aware of an investment opportunity for these funds that is expected to yield an ROl of 8.20 percent. Income Statement Sales revenue Cost of goods sold Gross margin Sales commission Depreciation expense Administrative expense Net income $800,000 (555, 000) $ 245,000 (50,000) (15,000) (75,950) $104,050 Balance Sheet Assets: Cash Manufacturing equipment, net of accumulated depreciation Office equipment, net of accumulated depreciation Total assets $757,050 390,000 47,000 $1,194,050 Equity: Common stock Retained earnings $1,090,000 104,050 $1,194,050 Total equity Required a-1. Calculate the existing ROl for Magnificent. a-2. Based on your computations will the President of Magnificent accept or reject the $300,000 investment opportunity?

Solution

EXISTING ROI A Net Income $104,050 B Total Assets $1,194,050 ROI=A/B Return on Investment (ROI) 0.0871404 Return on Investment (ROI) 8.71% Based on the computation,$300000investment opportunity will be rejected The investment opportunity will reduce the existing ROI C Required return 6.20% D=B*C Required return on existing investment $74,031 E Actual Return $104,050 F=E-D Residual Return of existing investment $30,019 G Required return on $300000 investment=300000*0.062= $        18,600 H Expected Return=0.082*300000= $        24,600 I=H-G Expected residual income $          6,000 Based on the computation,$300000investment opportunity will be accepted The investment opportunity will increase residual income