ExpertMedium1 markMultiple Choice
CPA · Question 12 · Area 1: Business Analysis
A company has a Return on Investment (ROI) of 18% and a Residual Income (RI) of $20,000. The company's required rate of return (hurdle rate) is 12%. What is the company's Average Invested Capital?
A company has a Return on Investment (ROI) of 18% and a Residual Income (RI) of $20,000. The company's required rate of return (hurdle rate) is 12%. What is the company's Average Invested Capital?
Answer options:
A.
$111,111
B.
$166,667
C.
$333,333
D.
$1,000,000
How to approach this question
Use the formula: Residual Income = (ROI - Cost of Capital) * Invested Capital. Rearrange to solve for Capital.
Full Answer
C.$333,333✓ Correct
The spread is 18% - 12% = 6%. This 6% excess return on capital equals $20,000. Therefore, Capital = $20,000 / 0.06 = $333,333.
Common mistakes
Trying to solve for Income first without realizing you can solve directly using the percentage spread.
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