Question

Ge-Lite mines minerals used in artistic paints. The mining process yields three products from a single process: red pigments, blue pigments, and a clay-like by-product. The three products emerge from a single mining process. For every 10 lbs of mineral, Ge-Lite can manufacture 3 lbs of red pigment, 4 lbs of blue pigment, and 3 lbs of clay-like by-product emerge.  

The red and blue pigments require additional processing before they can be sold. After additional processing, Ge-Lite can sell the red pigment for $15/lb and the blue pigment for $20/lb. Ge-Lite sells the clay-like by-product in bulk to a secondary distributor for $3.25/lb. It costs Ge-Lite $2.00/lb to transport the clay-like by-product to the secondary distributor.

In a typical month, Ge-Lite converts 80,000 lbs of mineral into the various pigments and the by-product, for a total joint cost of $580,000. If 80,000 lbs of minerals are used in production and Ge-Lite refines the minerals further, Ge-Lite incurs $43,000 in additional processing costs for the blue pigment, and $38,000 in additional processing costs for the red pigment.

The current mining process uses equipment with a current book value of $1,000,000. An investment opportunity arises such that Ge-Lite can update their equipment at an additional price of $800,000 which would generate 10,000 more lbs of mineral for the same processing cost/lb. This investment is paid for in cash. Further processing costs/lb would also remain fixed. Assume the firm’s cost of capital is 10%.

NOTE THAT YOU DO NOT NEED TO ALLOCATE THE JOINT COST TO ANSWER THE FOLLOWING QUESTIONS.

Required:

What is Ge-Lite's income with the new investment?

What is Ge-Lite's income without the new investment?

Assuming the manager is only concerned with the year following the investment opportunity, will the manager take the project if compensated based on Residual Income?

Assuming the manager is only concerned with the year following the investment opportunity, will the manager take the project if compensated based on Return on Investment?

Answer 1

1.

2.

3.

Upon analysing the above statements it can be said that the new investment is providing $128,750 ($497,750-369,000) additional income.

Hence, new investment proposal must be adopted.

4.

Return on Investment:

Computation of Return on investment:

As the return from investment with new investment is lower hence, the proposal of new investment must be rejected.