The manager of a division that produces add-on products for the automobile indus- try 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 $28.9 million and after-tax income of $3.179 million. The outlay required for each investment and the expected operating incomes are as follows:
| |
Air Conditioner
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Turbocharger
|
|
After-tax operating income
|
$ 67,500
|
$89,700
|
|
Outlay
|
750,000
|
690,000
|
Corporate headquarters will borrow up to $1.5 million for the automotive add- on division for further investments. The amount borrowed will be through unse- cured bonds at a rate of 12 percent. The marginal tax rate is 25 percent.
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.
Assuming that divisional managers are evaluated and rewarded on the basis of ROI performance, which alternative do you think the divisional manager will choose?
3. Suppose that the borrowing must be for the entire $1.5 million. Calculate the EVA of the two investments taken as a package. Based on EVA, are the invest- ments profitable?