Fraser Hotels is a decentralized organization with 10 properties. The general managers are evaluated on the basis of the return they are able to generate on invested assets with year-end bonuses given to the manager with the highest gross return on asset figures.

Operating results for one of the properties for the most recent year are:

Sales $10,000,000

Less Variable costs 6,000,000

Contribution margin 4,000,000

Less fixed expenses 3,200,000

Net operating income $ 800,000

Property's average operating assets $4,000,000

The company required a gross return on assets of 15% last year. This hotel has an opportunity to build an addition that would require an additional investment in operating assets of $1 million. The cost and revenue characteristics of the new addition per year would be:

Sales $2,000,000

Variable expenses 60% of sales

Fixed expenses $640,000

Required:

1. Compute this hotel's gross return on assets for the most recent year. (2 marks)
2. Compute the gross return on assets as it will appear if the addition is built. (2 marks)
3. As the general manager, would you accept or reject the project? Explain. (2 marks)

Suppose the company considers a return of 15% on invested assets as the minimum any division should earn, and that performance is evaluated by the residual income approach.

4. Compute the hotel's residual income for the most recent year. (2 marks)
5. Also compute the residual income as it will appear if the addition is built. (2 marks)
6. Under these circumstances, would you accept or reject the addition? Explain. (2 marks)