PLEASE SHOW WORK FOR RoR (Rate of Return)

O Group manages several fitness centers in EU & AS. Home office staff of O Group evaluates managers of O divisions by keeping track of the RoR each division earns on the avg. level of assets invested at the division. The home office staff considers 20%, which is O Groups after-tax cost of capital, to be the minimum acceptable annual RoR on avg. investment. When a divisions RoR drops below 20%, division MGMT can expect an unpleasant investigation by the home office & perhaps some firings. When the RoR exceeds 20% & grows through time, the home office staff is invariably pleased & rewards division MGMT. When the RoR exceeds 20% but declines over time, the home office staff sends out unpleasant memoranda & cuts the profit-sharing bonuses of the division managers.

Division A, avg. assets employed during the year amount to $60,000. Division A has been earning 40% per year on its avg. investment for several years. MGMT of Division A is proud of its extraordinary recordearning a steady 40% per year.

Division B, avg. assets employed during the year also amount to $60,000. Division B has been earning 25% per year on its avg. investment. In the preceding 3 yrs., the RoR on investment was 20%, 22%, & 23%, respectively. MGMT of Division B is proud of its record of steadily boosting earnings.

New investment opportunities have arisen at both Division A & B. In both cases, the new investment opportunity will require a cash outlay today of $30,000 and will provide a RoR on investment of 30% for each of the next 8 yrs. The avg. amount of assets invested in the project will be $30,000 for each of the next 8 yrs. Both new investment opportunities have positive net present value when the discount rate is 20% per year (the after-tax cost of capital of O Group).

When word of the new opportunities reached the home office staff, the prospects of the two new investments pleased the staff, because both investments would yield a better-than-avg. return for O Group.

MGMT of Division A computed its RoR on investment both with & without the new investment project and decided NOT to undertake the project. MGMT of Division B computed its RoR on investment both with & without the new investment project & decided to undertake it.

Questions: 1. Why did Division As MGMT turn down such a good opportunity? 2. What in the behavior of the home office staff induced Division As MGMT to reject the new project? 3. Is MGMT of Division B doing a better job than MGMT of Division A? 4. What may the home office do to give Division A an incentive to act in a way more consistent with the well-being of O Group?