Question: 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:
Air Conditioner Turbocharger
Outlay 750,000 P540,000
Operating Income 90,000 82,080
(Note: Round all numbers to two decimal places.)
Required: 1. Compute the ROI for each investment project.
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.
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?
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.
5. Suppose that the company sets a minimum required rate of return to 10%. Calculate the residua 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?