10-20 Return on investment, residual income, and economic value added (LO 3, 4)

Isabelle Abiassi operates a popular summer camp for elementary school children. Projections for the current year are as follows:

Sales revenue	$8,000,000
Operating income	$700,000
Average assets	$4,000,000

The camps weighted-average cost of capital is 10%, and Isabelle requires that all new investments generate a return on investment of at least 14%. The camps current tax rate is 25%.

At last weeks advisory board meeting, Isabelle told the board that she had up to $50,000 to invest in new facilities at the camp and asked them to recommend some projects. Today the boards president presented Isabelle with the following list of three potential investments to improve the camp facilities.

	Playground		Swimming Pool		Gym
Incremental operating income	$3,500		$4,800		$2,700
Average total assets	25,000		40,000		15,000

Required

a. Calculate the return on investment, residual income, and economic value added for each of the three projects.

b. Which of the three projects do you recommend Isabelle undertake? Why?