Assume Gibson Modems, Inc., is a division of Gilmore Business Products (GBP). GB

Question

Assume Gibson Modems, Inc., is a division of Gilmore Business Products (GBP). GBP uses ROI as the primary measure of managerial performance. GBP has a desired return on investment (ROI) of 5.20 percent. The company has $180,000 of investment funds to be assigned to its divisions. The president of Gibson is aware of an investment opportunity for these funds that is expected to yield an ROI of 5.80 percent.

Required

a-1. Calculate the existing ROI for Gibson.

a-2. Based on your computations will the President of Gibson accept or reject the $180,000 investment opportunity?

c-1. Calculate the estimated residual income of the new investment opportunity.

c-2. Based on the residual income would the President of Gibson accept or reject the $180,000 investment opportunity?

Req A1-A2

Req C1-C2

Income Statement Sales revenue $ 680,000 Cost of goods sold (495,000 ) Gross margin $ 185,000 Sales commission (38,000 ) Depreciation expense (10,000 ) Administrative expense (73,550 ) Net income $ 63,450

Explanation / Answer

A1 ANSWER:

ROI = (Net profit/total investment) *100

ROI for Gibson= (63450/180000)*100

=35.25 percent

A2 ANSWER:

Based on computations the president of Gibson reject investment opportunity.Because 35.25 percent is greater than 5.80 percent.

C1 ANSWER:

Residual income= operating income-(operating assets*cost of capital)

RI = 63450-[(728450+270000)*5.80%]

= 63450-[998450*5.8%]

=63450-57910

=5540

C2 ANSWER  

As residual income is net income after getting minimum rate of return and here it shows positive. so, the president of Gibson accept the residual income.

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