The manager of a division that produces kitchen appliances is considering the opportunity to invest in...

The manager of a division that produces kitchen appliances is considering the opportunity to invest in two independent projects. The first is a toaster and the second is a blender. Without the investments, the division will have total assets for the coming year of $14.5 million and after-tax income of $1.58 million. The invested capital required for each investment and the expected operating incomes are as follows:

Toaster Blender
After-tax operating income $33,750 $44,850
Invested capital 375,000 345,000

Corporate headquarters will obtain its financing for the kitchen appliances division’s further investments from long term debt and shares and the weighted average cost of capital is estimated to be 9 per cent.

Required:

Compute ROI for each investment project

Compute the budgeted divisional ROI for each of the following alternatives:
a. The toaster investment is made
b. The blender investment is made
c. Both investment are made
d. Neither 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?

Solutions

Expert Solution

Return on Investment (ROI):

ROI is defined as the ratio of net operating income to average operating assets for a given year. An investment with high ROI is usually preferable.

1. ROI for each investment project:

ROI for toaster project is

= Net operating income/ Capital investment

= 33,750 / 375,000

= 9%

ROI for blender project is

= Net operating income/ Capital investment

= 44,850 / 345,000

= 13%

Budgeted Divisional ROI for each alternatives:

	Toaster investment	Blender investment	Both investment	Neither investment
Operating Income (A)	$1,613,750 (1,580,000+33750)	$1,624,850 (1,580,000+44850)	$1,658,600 (1,580,000+33750+44850)	$1,580,000
Assets (B)	$14,875,000 (14,500,000+375,000)	$14,845,000 (14,500,000+345,000)	$15,220,000 (14,500,000+375,000+3,45,000)	$14,500,000
ROI (A/B)	10.85%	10.95%	10.9%	10.9%

Based on ROI, the divisional managers will choose the blender investment.

ekkarill92 answered 1 year ago

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