Figure 12-2. The manager of Stock Division projects the following for next year:
The manager can invest in an additional project that would require $40,000 investment in additional assets and would generate $6,000 of additional income.The company's minimum rate of return is 14%.
Refer to Figure 12-2.What is the residual income for Stock Division with the additional project?
A)$40,000
B)$6,000
C)$7,900
D)$4,200
E)$25,600

Question

Figure 12-2. The manager of Stock Division projects the following for next year:
 The manager can invest in an additional project that would require $40,000 investment in additional assets and would generate $6,000 of additional income.The company's minimum rate of return is 14%.
Refer to Figure 12-2.What is the residual income for Stock Division with the additional project?
A)$40,000 
B)$6,000 
C)$7,900 
D)$4,200 
E)$25,600

Quizplus · Accepted Answer

To calculate the residual income with the additional project, we first compute the division's current income:

Current income = $200,000 - ($1,500,000 x 14%) = $200,000 - $210,000 = -$10,000

The negative result indicates that the division is not meeting the company's minimum rate of return.

Next, we calculate the income from the additional project:

Additional income = $6,000

The additional investment required is $40,000, so the return on investment from the additional project is:

ROI = $6,000 / $40,000 x 100% = 15%

Since the ROI exceeds the minimum rate of return of 14%, the additional project should be accepted.

Finally, we calculate the residual income with the additional project:

Residual income = Current income + Income from additional project - (Minimum rate of return x Total assets)

= -$10,000 + $6,000 - (14% x $1,540,000)

= $7,900

Therefore, the best choice is C, with a residual income of $7,900.