ABC Division currently has an operating profit of $3.75 million on average operating assets of $21 million. ABC is considering investing in two projects:

Project #1 Project #2

Required Investment $1,250,000 $ 750,000

Annual Revenue or Cost Savings $ 200,000 $175,000

ABC’s division manager receives a bonus each year which is tied to the ROI of ABC. Corporate headquarters has made $2.5 million in capital available to ABC. Any unused funds would be invested at the corporate level at an expected rate of 10%.

1. Compute the current division ROI and the ROI of each project.

2. Calculate the new ROI for ABC Division based on: a) adding Project #1; b) adding Project #2, and c) adding Project #1 and Project #2.

3. What investment option is ABC’s manager likely to choose? What are you assuming is motivating the manager?

4. Which investment alternative is in the best interest of the overall company? Why? (Calculations not needed.)

5. Calculate the residual income of each project (use 10% as the minimum return). Also calculate the new Residual income for ABC Division based on all possible investment alternatives.

6. What investment option would ABC choose if the division manager were evaluated based on RI?