To produce Tracker, operating assets will have to increase $2,000,000. Tracker is expected to generate an additional $260,000 of controllable margin. How will the Tracker effect ROI?
|
|
Without tracker |
Tracker |
With Tracker |
|
Controllable margin |
$1,000,000 |
$260,000 |
$1,260,000 |
|
Average operating assets |
$5,000,000 |
$2,000,000 |
$7,000,000 |
The problem with this ROI analysis is that it ignores the minimum rate of return on a company’s operating assets.
To evaluate performance using minimum rate of return, companies use the residual income approach. Residual income is the income that remains after subtracting from the controllable margin the minimum rate of return on a company’s average operating assets.
How does residual income change as the additional investment is made?