A division has net assets of $1,600,000 and annual profit of $240,000. It is considering an investment of $400,000 that would generate an extra annual profit of $56,000. The company's cost of capital is 12%. If the investment goes ahead, which of the following is correct?

Correct answer: B) Divisional ROI falls to 14.8%, but divisional residual income rises by $8,000

Explanation

Current ROI = 240,000 / 1,600,000 = 15.0%. New ROI = (240,000 + 56,000) / (1,600,000 + 400,000) = 296,000 / 2,000,000 = 14.8%. Project RI = 56,000 - (400,000 x 12%) = 56,000 - 48,000 = $8,000, so divisional RI rises from 48,000 to 56,000, an increase of $8,000. 18.5% wrongly leaves the new assets out of the denominator.