RETURN ON INVESTMENT AND ECONOMIC VALUE ADDED CALCULATIONS WITH VARYING ASSUMPTIONS Knitpix Products is a division of Parker Textiles Inc. During the coming year, it expects to earn income of $310,000 based on sales of $3.45 million; without any new investments, the division will have average operating assets of $3 million. The division is considering a capital investment project—adding knitting machines to produce gaiters—

that requires an additional investment of $600,000 and increases net income by

$57,500 (sales would increase by $575,000). If made, the investment would increase beginning operating assets by $600,000 and ending operating assets by $400,000. Assume that the actual cost of capital for the company is 7 percent.

Required:

. Compute the ROI for the division without the investment.

. Compute the margin and turnover ratios without the investment. Show that the product of the margin and turnover ratios equals the ROI computed in Requirement 1.

. Compute the ROI for the division with the new investment. Do you think the division manager will approve the investment?

. Compute the margin and turnover ratios for the division with the new investment.

Compare these with the old ratios.

. Compute the EVA of the division with and without the investment. Should the manager decide to make the knitting machine investment?

Problem