Preston Plastics is about to wrap up its capital budgeting cycle, and department managers across the company have submitted 500 capital project requests for consideration in the next round of funding. Preston's CFO, Dan LaMontagne, is trying to decide which projects to recommend for funding to the capital projects executive committee. He has gathered all the information about each project's estimated life, initial investment, and cash flows in an Excel spreadsheet and is ready to make his decisions. Dan's performance bonus is based on improving the company's overall ROI. The company requires a 16% minimum ROI and currently has an 18% ROI.

Required

a. Calculate the return on investment for each individual proposed project. Save your work to use in answering the remaining questions. NOTE: Remember that ROI is based on income, not cash flows. You will need to subtract the annual straight line depreciation from the cash flow to estimate the operating income for each project.

b. Calculate the residual income for each individual proposed project. Save your work to use in answering the remaining questions. NOTE: Remember that residual income is based on income, not cash flows. You will need to subtract the annual straight line depreciation from the cash flow to estimate the operating income for each project.

c. What is the overall ROI and residual income for the portfolio of proposed projects?

d. Recall that Dan's performance bonus is based on increasing the company's ROI at the end of the year. Using return on investment as the decision criterion and assuming the company has $2 billion to invest in new capital projects, what decision rule is Dan likely to use in allocating funds to new capital projects? With this rule, how many projects will Dan likely recommend for funding? What is the total amount of capital funds that will be allocated? Hint: Sort the data by return on investment and calculate a running sum of project investment to help you determine which projects can be funded.

e. Assume that Dan's performance bonus is based on increasing the company's residual income at the end of the year. Using residual income as the decision criterion and assuming the company has $2 billion to invest in new capital projects, what decision rule is Dan likely to use in allocating funds to new capital projects? With this rule, how many projects will Dan likely recommend for funding? What is the total amount of capital funds that will be allocated? Hint: Sort the data by residual income and calculate a running sum of project investment to help you determine which projects can be funded.

f. Look at project 16934. What is the funding decision for this project based on ROI?

What is the funding decision based on residual income? Why do your funding decisions differ based on the evaluation criterion used?

g. Which funding criterion do you recommend Preston Plastics use to maximize corporate welfare? Why?

The Excel data files for answering this problem can be found in Wiley PLUS.