Question

Return on Investment for Multiple Investments, Residual Income The manager of a 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 $29.4 million and expected operating income of $4.335 million. The outlay required for each investment and the expected operating incomes are as follows: Air conditioner Turbocharger Outlay $540,000 $950,000 90,000 Operating income 90,080 Required: 1. Compute the ROI for each investment project. Round to the nearest whole percent. Air conditioner, ROI Turbocharger, ROI 2. Compute the budgeted divisional ROI for each of the following four alternatives. Round to two decimal places. 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. Conceptual Connection: Assuming that divisional managers are evaluated and rewarded on the basis of ROI performance, which alternative do you think the divisional manager will choose?

Answer 1

ROI = Operating Income/Average Assets
Air Conditioner	9.47%
Turbocharger	16.68%
2.a. Air conditioner is made	14.58%
Turbocharger is made	14.78%
Both are made	14.62%
Neither	14.74%
Choose Only Turbocharger i.e. b
Residual Income = Operating income - Average Investment*Minimum rate of return
2.a. Air conditioner is made	176,000
Turbocharger is made	233,480
Both are made	190,480
Neither	219,000
Choose Only Turbocharger i.e. b
At 10%
2.a. Air conditioner is made	1,390,000
Turbocharger is made	1,431,080
Both are made	1,426,080
Neither	1,395,000
Choose Both i.e. C