Question

i) Compute the return on investment (5mks)

ii) Compute residual income assuming that the company requires a 10% interest on total assets of each subsidiary (5mks)

iii) Assume that there is an asset available to subsidiary A which costs Ksh. 100,000 which has an annual profit of Ksh. 20,000. Advice the manager of A on whether to undertake the project and comment on whether this decision is in line with the overall objective of the organization (5mks)

Answer 1

a) $Return on investment = 270 / 6500 = 0.042 = 4.2$

b). $Residual income = profit after tax - imputed cost Residual income = 270-0.1*6500 = -380$

c). $New return on investment = 290/ 6600 = 0.044 = 4.4$

The firm should purchase the new asset because it will help the firm to increase the return on investment