Question

In: Accounting

An auto parts Company produces various extra additions to motor cars. It has just discovered an...

An auto parts Company produces various extra additions to motor cars. It has just discovered an opportunity to invest in producing air conditioners for the back seats of vans and minibuses. The investment project will cost $925,000 and will generate an estimated additional operating income of $95,500.

Without the investment, the company will have average assets for the coming year of $29.5 million and expected operating income of $4.535 million.

Required:

  1. What is the ROI of the new investment project alone? Is it higher or lower than the existing ROI of the company?

  1. What will be the ROI of the company after accepting the new investment?

  1. Assuming that the managers are evaluated and rewarded on the basis of ROI performance, should a rational manger make the new investment? Why?

  1. Suppose that the company sets a minimum required rate of return to 11%. What will be the ‘Residual Income’ of the company after accepting the new investment? Is it higher or lower than the Residual Income without the investment?

  1. What will be the Economic value Added (EVA) of the company after making the new investment if corporate tax rate is 30% and the actual cost of capital of the company is 10%?

Solutions

Expert Solution

1.

ROI = Operating income / average assets

ROI of the new investment project alone

ROI = 95500 / 925000 = 0.1032 or 10.32%

existing ROI = 4.535 million / 29.5 million = 0.1537 or 15.37%

* The ROI of the new investment project alone is lower than the existing ROI

2.

ROI of the company after accepting the new investment

ROI = ( 4535000 + 95500 ) / ( 29500000 + 925000 ) = 0.1522 or 15.22%

3.

Assuming that the managers are evaluated and rewarded on the basis of ROI performance, should a rational manger make the new investment? Why?

No, because it is decrease the overall ROI of the company will decreased.

4.

Suppose that the company sets a minimum required rate of return to 11%. What will be the ‘Residual Income’ of the company after accepting the new investment? Is it higher or lower than the Residual Income without the investment?

RI = Operating income - ( Investment * Required rate )

RI after accepting new opportunity

Operating income = 4535000 + 95500   =4630500

Investment = 29500000 + 925000 = 30425000

required rate of return to 11%

RI = 4630500 - ( 30425000 * 11% ) = 4630500 - 3346750 = 1283750

RI without new opportunities

Operating income = 4535000

Investment = 29500000

required rate of return to 11%

RI = 4535000 - ( 29500000 * 11% ) = 1290000

* RI after accepting new investment is lower than the Residual Income without the investment

5.

What will be the Economic value Added (EVA) of the company after making the new investment if corporate tax rate is 30% and the actual cost of capital of the company is 10%?

EVA = operating income after tax - ( Investment * cost of capital )

After new investment

operating income after tax = 4535000 + 95500   =4630500 - 30% = 3241350

Investment = 29500000 + 925000 = 30425000

Cost of capital = 10%

EVA = 3241350 - ( 30425000 * 10% )

EVA = 3241350 - 3042500 = 198850

ekkarill92 answered 1 month ago
Next > < Previous

Related Solutions

Honda motor company has four vehicle manufacturing plants in various parts of the country. It is...
Honda motor company has four vehicle manufacturing plants in various parts of the country. It is considering producing its own batteries for the vehicles that it builds instead of purchasing them from outside vendors. It could build one centralized location with a cost of $1,500,000 and each battery would cost $100, including shipping. If it builds four battery manufacturing plants near the vehicle manufacturing plants, each battery plant would cost $500,000 each, but the battery cost would be $80. Show...
29. Auto parts limited has an annual production of 90,000 units for a motor component. The...
29. Auto parts limited has an annual production of 90,000 units for a motor component. The component’s cost structure per unit is given below: Materials Rs. 2.70; labour (25% fixed) Rs. 180; Variable Expenses Rs. 90; Fixed Expenses Rs. 135; Total Rs. 675; The purchase manager has an offer from a supplier who is willing to supply the component at Rs. 540. Should the component be purchased? Assuming that the resources now used for the purpose of this components manufacture...
Auto Parts, Inc. is medium-sized company that manufactures auto parts in Buffalo, New York. The company...
Auto Parts, Inc. is medium-sized company that manufactures auto parts in Buffalo, New York. The company currently loses $30,000 per month. The owner of the company is evaluating whether she should shut down the factory. She thinks that the factory should continue to operate until the economic environment improves and buyer for the factory can be identified. The logic of the owner is that her company has already invested millions of dollars in the factory over the years. The monthly...
2 parts: Part B is different numbers a.)Each extra worker produces two extra units of output...
2 parts: Part B is different numbers a.)Each extra worker produces two extra units of output up to 4 workers. After 4 workers, each extra worker produces one extra unit of output. Draw the total product, average product of labor and marginal product of labor curves on two graphs. b.)Suppose inputs are only substitutable at two units of labor for every one unit of capital. Assume that the production function q = f(L, K) has constant returns to scale and...
Sharp Motor Company has two operating divisions—an Auto Division and a Truck Division. The company has...
Sharp Motor Company has two operating divisions—an Auto Division and a Truck Division. The company has a cafeteria that serves the employees of both divisions. The costs of operating the cafeteria are budgeted at $77,000 per month plus $0.50 per meal served. The company pays all the cost of the meals. The fixed costs of the cafeteria are determined by peak-period requirements. The Auto Division is responsible for 69% of the peak-period requirements, and the Truck Division is responsible for...
Sharp Motor Company has two operating divisions—an Auto Division and a Truck Division. The company has...
Sharp Motor Company has two operating divisions—an Auto Division and a Truck Division. The company has a cafeteria that serves the employees of both divisions. The costs of operating the cafeteria are budgeted at $85,000 per month plus $0.50 per meal served. The company pays all the cost of the meals.         The fixed costs of the cafeteria are determined by peak-period requirements. The Auto Division is responsible for 58% of the peak-period requirements, and the Truck Division is responsible for...
Sharp Motor Company has two operating divisions—an Auto Division and a Truck Division. The company has...
Sharp Motor Company has two operating divisions—an Auto Division and a Truck Division. The company has a cafeteria that serves the employees of both divisions. The costs of operating the cafeteria are budgeted at $76,000 per month plus $0.50 per meal served. The company pays all the cost of the meals. The fixed costs of the cafeteria are determined by peak-period requirements. The Auto Division is responsible for 71% of the peak-period requirements, and the Truck Division is responsible for...
Makari Motura parts manufacturers produce various motor parts. The cost structure of a part which production...
Makari Motura parts manufacturers produce various motor parts. The cost structure of a part which production per annum is 90,000 units is as follows:                                                                                    Sh.            Materials (per unit)                                   540            Labour (25% fixed)                                     360            Expenses:            Variable (Per unit)                                     180             Fixed                                                           270            Total                                                            1,350                                                         The purchasing manager explores that a supplier is ready to supply the part at Sh. 1080. Required: Explain whether the part should be purchased and production stopped or not. Show...
A manufacturing company makes auto parts and sells them to auto dealers.
 A manufacturing company makes auto parts and sells them to auto dealers. Last week the company shipped 25 auto parts to a dealer. Later it found out that 5 of those parts were defective. By the time the company manager contacted the dealer 4 auto parts from that shipment had already been sold. What is the probability that 3 of those 4 parts were non-defective?
A manufacturing company has two divisions: Motor and Pump. The Motor Division produces an intermediate good,...
A manufacturing company has two divisions: Motor and Pump. The Motor Division produces an intermediate good, which is a motor that can be used as an input for the Pump Division. The Motor Division also sells the motors in the open market. The Pump Division assembles the parts together to make water pumps which are sold to the consumers. The Pump Division needs an average of 10,000 motors every year. A transfer price based on the variable cost is mandated....
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT