EXERCISE 12-12 (CONTINUED)

3. a. and b.

Division A Division B Division C

Return on investment (ROI) ... 20% 8% 16%

Therefore, if the division is pre-

sented with an investment op-

portunity yielding 15%, it

probably would... Reject Accept Reject

Minimum required return for com-

puting residual income... 14% 10% 16%

probably would... Accept Accept Reject

If performance is being measured by ROI, both Division A and Division C

probably would reject the 15% investment opportunity. These divisions’

ROIs currently exceed 15%; accepting a new investment with a 15%

rate of return would reduce their overall ROIs. Division B probably would

accept the 15% investment opportunity, since accepting it would in-

crease the division’s overall rate of return.

If performance is measured by residual income, both Division A and Di-

vision B probably would accept the 15% investment opportunity. The

15% rate of return promised by the new investment is greater than their

required rates of return of 14% and 10%, respectively, and would there-

fore add to the total amount of their residual income. Division C would

reject the opportunity, since the 15% return on the new investment is

less than its 16% required rate of return.