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.Which of the following statements is true?
A)If the manager invests in the additional project,ROI of the division will decrease.
B)The residual income of the project is less than the residual income of the division without the project; therefore the project will be rejected.
C)Average investment for Stock Division will decrease if the project is accepted for investment.
D)If the manager invests in the additional project,residual income of the division will increase.
E)none of these.

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.Which of the following statements is true?
A)If the manager invests in the additional project,ROI of the division will decrease. 
B)The residual income of the project is less than the residual income of the division without the project; therefore the project will be rejected. 
C)Average investment for Stock Division will decrease if the project is accepted for investment. 
D)If the manager invests in the additional project,residual income of the division will increase. 
E)none of these.

Quizplus · Accepted Answer

If the manager invests in the additional project, the division's income will increase by $6,000. However, the additional investment of $40,000 must also be taken into account. Using ROI, the return on investment would be calculated as ($70,000 + $6,000)/($310,000 + $40,000), or approximately 19%. This exceeds the minimum rate of return of 14%, so the project should be accepted. With the additional income, the residual income of the division will increase, not decrease. The average investment for the division will increase, not decrease, with the additional investment.