NEW CASTLE DIVISION

An individual Business Case

Presented to the
Accountancy Department
De La Salle University

In partial fulfillment
Of the course requirements
In ACCTBA3 Section K40

SUBMITTED TO:
Ms. Baarde, Ma. Victoria

SUBMITTED BY:
Belarmino, Katrina Bianca L.

August 24, 2016

The manager of the NEW CASTLE division that produces add-on products for the
automobile industry has just been presented the opportunity to invest in two

independent projects. The first is an air conditioner for the back seats of vans and
minivans. The second is a turbocharger. Without the investments, the division will
have average assets for the coming year of P28.9 million and expected operating
income of P4.335 million.

The outlay required for each investment and the

expected operating income are as follows:

Outlay
Operating Income

Air Conditioner
P750,000
90,000

Turbocharger
P540,000
82,080

(Note: Round all numbers to two decimal places.)

Required:
1. Compute the ROI for each investment project.
Answer:

ROI =

Net operating Income

Average operating assets

Air Conditioner
Net Income = P90,000

Turbocharger
Net Income = P82,080

AOA = P750,000

AOA = P540,000

ROI =

P 90,000
P 750000

ROI=0.12 or 12%

ROI =

P 90,000
P 750000

ROI=0.12 or 12%

2. Compute the budgeted divisional ROI for each of the following four
alternatives:
a. The air conditioner investment is made.
b. The turbocharger investment is made.
c. Both investments are made.
d. Neither additional investment is made.

Answer:
Net Income = P 4,335,000
a. Air

conditioner

Average

investment

is

made

operating

P28,900,000
b. Turbocharger

Assets
investment

NOI = P82,080 AOA = P540,000

ROI =

P 90,000+ P 4,335,000
P 750000+ P 28,900,000

ROI =

P 82,080+ P 4,335,000
P 540,000+ P 28,900,000

ROI =

P 4,425,000
P 29,650,000

ROI =

P 4,417,080
P 29,440,000

ROI = 0.1492 or 14.92%

c. Both Investments are made

ROI = 0.1500 or 15%

d. Neither additional investment is

NOI = P90,000 AOA = P750,000

made

NOI = P82,080 AOA = P540,000

ROI

P 90,000+ P 82,080+ P 4,335,000

P 750000+ P 540,000+ P28,900,000

ROI =

P 4,335,000
P 28,900,000

ROI = 0.15 or 15%

P 4,507,080
P 30,190,000

ROI = 0.1493 or 14.93%

3. Assuming that divisional managers are evaluated and rewarded on the basis
of ROI performance, which alternative do you think the divisional manager
will choose?
Answer:
-

is

made

NOI = P90,000 AOA = P750,000

ROI =

Four alternatives were proposed to the divisional manager and several

computations were computed. We computed for the Return on Investment
on each alternative. From the ROI computed, it gave us the results that

the highest ROI were the turbocharger investment and neither investment
were made. Both resulted with a ROI of 15%. I will recommend that the
divisional manager should choose between either the 2 alternatives
because both would give the same return on investment which will benefit
the company.
4. Suppose the company sets a minimum required rate of return equal to 14%.
Calculate the residual for each of the following four alternatives:
a. The air conditioner investment is made.
b. The turbocharger investment is made.
c. Both investments are made.
d. Neither additional investment is made
Which option will the manager choose based on residual income? Explain.
Answer:
Residual Income = Net operating Income-(Minimum rate X Average
operating assets)

Net Income = P 4,335,000

Average

Minimum rate of return = 14%

P28,900,000

a. Air

conditioner

investment

is

b. Turbocharger

made
NOI = P90,000 AOA = P750,000
RI = (P90,000+P4,335,000)-[0.14 X
(P28,900,000+P750,000)]
RI = P4,425,000 (0.14 X
P29,650,000)
RI = P274,000

c. Both Investments are made

operating

Assets
investment

=
is

made
NOI = P82,080 AOA = P540,000
RI = (P82,080+P4,335,000)-[0.14 X
(P28,900,000+P540,000)]
RI = P4,417,080 (0.14 X
P29,440,000)
RI = P295,480

d. Neither additional investment is

NOI = P90,000 AOA = P750,000

made

NOI = P82,080 AOA = P540,000

RI = P4,335,000-(0.14 X
RI =

P28,900,000)

(P90,000+P4,335,000+P82,080)-[0.14

RI = P289,000

X (P28,900,000+P750,000+P540,000)]
RI = P4,507,080 (0.14 X
P30,190,000)
RI = P280,480
-

Base from the computed residual income of each alternative, the best
option that the manager will choose would probably be the turbocharger
investments. With a minimum rate of return of 14%, this option has the
highest RI with an RI of P295,480 which the company can benefit. using RI
as a performance measure is an effective way to minimize the conflict
between company goals and division goals that arise using ROI.

5. Suppose that the company sets a minimum required rate of return to 10%.
Calculate the residual income for each of the following four alternatives:
a. The air conditioner investment is made.
b. The turbocharger investment is made.

c. Both investments are made.

d. Neither additional investment is made.
Based on residual income, are the investments profitable? Why does answer differ
from your answer in requirement 3?

Answer:
Net Income = P 4,335,000

Average

Minimum rate of return = 10%

P28,900,000

a. Air

conditioner

investment

is

made
NOI = P90,000 AOA = P750,000
RI = (P90,000+P4,335,000)-[0.10 X
(P28,900,000+P750,000)]
RI = P4,425,000 (0.10 X
P29,650,000)
RI = P1,460,000

c. Both Investments are made

NOI = P90,000 AOA = P750,000

operating

b. Turbocharger

Assets
investment

NOI = P82,080 AOA = P540,000

RI = (P82,080+P4,335,000)-[0.10 X
(P28,900,000+P540,000)]
RI = P4,417,080 (0.10 X
P29,440,000)
RI = P1,473,080

d. Neither additional investment is

made
RI = P4,335,000-(0.10 X

(P90,000+P4,335,000+P82,080)-[0.10
X (P28,900,000+P750,000+P540,000)]
RI = P4,507,080 (0.10 X
P30,190,000)
RI = P1,488,080

is

made

NOI = P82,080 AOA = P540,000

RI =

P28,900,000)
RI = P1,445,000

Base from the results of each RI of the alternatives, all of it are profitable. As stated
above, in divisional comparison, the alternative with the greater size will have a
greater residual income. In the situation, the highest RI is both investments are
made with a RI of P1,488,080. On the other hand, compared from other
requirement, they have a different minimum required rate of return. Based from
what I observed from the RI with different minimum required rate of return, the
lower the minimum rate, the higher the residual income. Therefore, the rate can
help the manager in making decisions for the company.

References
Larucket. (n.d.). Using Residual Income (RI) to Evaluate Performance. Retrieved
August 24,
2016, from http://2012books.lardbucket.org/books/accounting-formanagers/s15-05-using-residual-income-ri-to-ev.html