RETURN ON INVESTMENT FOR MULTIPLE INVESTMENTS,

RESIDUAL INCOME The manager of a division that produces add-on products for the automobile industry has just been presented the opportunity to invest in two independent projects. The first is an air conditioner for the back seats of vans and minivans. The second is a turbocharger. Without the investments, the division will have average operating assets for the coming year of $28.9 million and expected operating income of $4.335 million. The outlay required for each investment and the expected operating incomes are as follows:

Air Conditioner Turbocharger Outlay $750,000 $540,000 Operating income 90,000 82,080 Required:

. Compute the ROI for each investment project.

. Compute the budgeted divisional ROI for each of the following four alternatives:

a. The air conditioner investment is made.

b. The turbocharger investment is made.

c. Both investments are made.

d. Neither additional investment is made.

Assuming that division managers are evaluated and rewarded on the basis of ROI performance, which alternative do you think the division manager will choose?

. Suppose that the company sets a minimum required rate of return equal to 14 percent. Calculate the residual income for each of the following four alternatives:

a. The air conditioner investment is made.

b. The turbocharger investment is made.

c. Both investments are made.

d. Neither additional investment is made.
Which option will the manager choose based on residual income? Explain.
. Suppose that the company sets a minimum required rate of return equal to 10 percent. Calculate the residual income for each of the following four alternatives:

a. The air conditioner investment is made.

b. The turbocharger investment is made.

c. Both investments are made.

d. Neither additional investment is made.
Based on residual income, are the investments profitable? Why does your answer differ from your answer in Requirement 3?
Problem