The New Products Division of Testar Company has developed a potential new product that would require $8,500,000 in operating assets and would be expected to provide $1,400,000 in operating income each year.Testar has set a target return on investment (ROI)of 16% for each of its divisions.Which of the following statements is accurate?
A) The new product is acceptable because it will yield an ROI that is higher than the target ROI and will yield residual income of $40,000.
B) The new product will yield residual income of $45,000.
C) The new product will decrease the companywide ROI.
D) The new product is unacceptable because it will yield an ROI that is lower than the target ROI.

Question

Quizplus · Accepted Answer

The ROI of the new product can be calculated as Operating Income/Operating Assets = $1,400,000/$8,500,000 = 16.47%. 
Since this is higher than the target ROI of 16%, the new product is acceptable. 
Additionally, the residual income can be calculated as Operating Income - (Operating Assets x Required Rate of Return) = $1,400,000 - ($8,500,000 x 0.16) = $40,000. Therefore, the correct statement is that the new product is acceptable because it will yield an ROI that is higher than the target ROI and will yield residual income of $40,000.

The New Products Division of Testar Company Has Developed a Potential