Measuring Performance: Residual Income and ROI
Response to the following problem:
The gaming division of Nevada Corporation had income of $550,000 and total assets of $3 million in 2009. The figures are expected to be similar in 2010. The manager of the gaming division has an opportunity to purchase some new gambling machines for $250,000. He concludes that the new machines would increase annual operating profit by $44,000.
Required:
1. Calculate the current ROI and the expected return on the proposed investment.
2. Calculate the gaming division's current residual income and the expected residual income on the proposed investment. (Assume that the division's minimum accepted rate of return is 17%.)
3. Should the new machines be purchased:
a. If the division uses the ROI method?
b. If the division uses the residual income method?