Sam L H. answered • 10/26/15

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The answer is option A) as stated above. To understand why we selected the A) answer we have to keep in mind that the Clipper Corp as a whole has a required minimum return of 18% on new projects.

The division currently earn 20% return on investment and the new project it is considering is estimated to yield 18.6%, this is derived from dividing 13,000 by 70,000. So if this investment is considered the division's current return will be lower than 20% (20,000/100000+13,000/70,000= 19.4%. The new rate 19.4% in this case is higher than the required return called for by the corporation which is 18%, therefore the division manager ought to accept the new investment.

The difference between between ROI and Residual Income is the cost of capital. The cost of capital under RI is deducted from Operating income. In the above problem no cost of capital was given and therefore assuming zero cost of capital (interest) will yield the same result as ROI which is stated above.