Return on Investment Quiz

QUESTIONS

1. Return on investment (ROI) is calculated as...

        A) Net Income ÷ Assets

        B) Assets ÷ Net Income

 

2. The term "return" can also be defined as...

        A) The profit on an investment

        B) The amount of an investment

 

3. A typical return on investment for a company with a large asset base might be...

        A) 10% - 20%

        B) 40% - 50%

 

4. Company A and Company B have the same net income, but Company A has a larger asset base. Which company will have a higher ROI?

        A) Company A

        B) Company B

 

5. Company A and Company B have the same size asset base, but Company A earns a high net income. Which company will have a higher ROI?

        A) Company A

        B) Company B

 

6. Residual income is calculated as...

        A) Income - Target Return in Dollars

        B) ROI - Target Return in Dollars

 

7. The required rate of return is a percentage...

        A) Chosen by management

        B) Automatically calculated

 

8) The target return in dollars is calculated as...

        A) Asset Base x Required Rate of Return

        B) Net Income x Required Rate of Return

 

9) EBITDA is defined as...

        A) Earnings Before Interest, Taxes, Depreciation, and Amortization

        B) Earnings Beyond Interest, Taxes, Depreciation, and Amortization

 

10) EBITDA is more closely related to...

        A) Operational Success

        B) Overall Success

 

ANSWER KEY:

1A, 2A, 3A, 4B, 5A, 6A, 7A, 8A, 9A, 10A

 

PRACTICE PROBLEMS

Company A has the following:

        -Net Income: $500,000

        -Assets: $5,000,000

        -Required Rate of Return: 9%.

 

1. What is its ROI?

2. What is its target return in dollars?

2. What is its residual income?

 

Company B has the following:

        -Total Revenues: $1,000,000

        -Total Expenses: $650,000

        -Required Rate of Return: 13%

        -Liabilities: $500,000

        -Equity: $3,000,000

 

4. What is its ROI?

5. What is its target return in dollars?

6. What is its residual income?

7. Company A starts the year with an asset base of $2,000,000 and ends the year with an asset base of $4,000,000. During the year, it had $300,000 of net income. What is Company A's ROI?

8. Manager A currently has a 13% ROI on the division under his control. Manager B currently has a 15% ROI on the division under his control. There is a new investment opportunity that promises a 14% ROI. If the company evaluates its managers on the basis of ROI, which of the managers will take the investment?

9. Manager A currently has a 13% ROI on the division under his control. Manager B currently has a 15% ROI on the division under his control. There is a new investment opportunity that promises a 14% ROI. If the company evaluates its managers on the basis of RI (residual income) and sets the required rate of return at 12%, which of the managers will take the investment?

 

 

ANSWER KEY:

1.

ROI = Net Income ÷ Assets

ROI = $500,000 ÷ $5,000,000

ROI = 10%

 

2.

Target Return in Dollars = Assets x Required Rate of Return

Target Return in Dollars = $5,000,000 x 9%

Target Return in Dollars = $450,000

 

3.

Residual Income = Net Income - Target Return in Dollars

Residual Income = $500,000 - $450,000

Residual Income = $50,000

 

4. 

ROI = Net Income ÷ Assets

Net Income = Total Revenues - Total Expenses

Net Income = $350,000

Assets = Liabilities + Owners' Equity

Assets = $3,500,000

ROI = $350,000 ÷ $3,500,000 = 10%

 

5.

Target Return in Dollars = Assets x Required Rate of Return

Target Return in Dollars = $3,500,000 x 13%

Target Return in Dollars = $455,000

 

6.

Residual Income = Net Income - Target Return in Dollars

Residual Income = $350,000 - $455,000

Residual Income = ($105,000)

* In this case, the company has a negative residual income figure. The company's net income of $350,000 didn't mean the minimum threshold that management was hoping to return. The company needs to reevaluate how it allocates its resources.

 

7.

When given starting and ending balance sheet figures and asked to use them in a calculation, it is best to take the average of the two figures.

($2,000,000 + $4,000,000) ÷ 2 = $3,000,000 average asset base on the year

ROI = Net Income ÷ Assets

ROI = $300,000 ÷ $3,000,000 = 10%

 

8.

If the company evaluates its managers on the basis of ROI, only Manager A will take the investment, since it would lower the ROI of Manager B.

 

9.

In this case, both Manager A and Manager B will take the investment because the expected ROI of 14% is greater than management's minimum threshold (required rate of return) of 12%.