Question

Lumberton Home Maintenance Company (LHMC) earned operating income of $6,000,000 on operating assets of $62,500,000 during Year 2. The Tree Cutting Division earned $1,000,000 on operating assets of $10,000,000. LHMC has offered the Tree Cutting Division $1,250,000 of additional operating assets. The manager of the Tree Cutting Division believes he could use the additional assets to generate operating income amounting to $112,500. LHMC has a desired return on investment (ROI) of 8 percent.

Required
a. Calculate the return on investment for LHMC, the Tree Cutting Division, and the additional investment opportunity.
b. Calculate the residual income for LHMC, the Tree Cutting Division, and the additional investment opportunity

Answer 1

Answer:

Lumberton Home Maintenance Company (LHMC)

                                           LHMC         Tree Cutting        Additional

                                                                   Division         Investment

a. Return on Investment    9.6%                10%                     9%

b. Residual income      $1,000,000        $200,000            $12,500

Explanation:

a) Data and Calculations:

                                           LHMC         Tree Cutting        Additional

                                                                   Division         Investment

Operating income       $6,000,000      $1,000,000           $112,500

Operating assets      $62,500,000    $10,000,000      $1,250,000

a. Return on Investment    9.6%                10%                     9%

b. Residual income      $1,000,000        $200,000            $12,500

Return on investment = Operating income/Operating assets * 100

Residual income = Operating income Minus (Desired ROI * Operating assets)

Desired Return on Investment (ROI) = 8%