Problem 2

Eliotts Electronics has the opportunity to invest in two projects: a home security system and a soundbar speaker system. The security system will require an investment of

$ 15,000,000 in assets and is expected to generate $ 1,920,000 in operating income. The speaker system will require an investment of $ 8,000,000 in assets and is expected to generate $ 1,050,000 in operating income. Currently the firm has operating income of

$ 13,400,000 and is utilizing $ 83,750,000 in assets. The firm has $ 24,000,000 available for new investments. Corporate headquarters requires that all investments earn at least a 12% return. The firm is considering the following options:

Maintain current operations only;

Add the home security system only;

Add the soundbar system only;

Add both projects.

A. For each of these options, compute the firms total return on investment. (Round to four decimal places (e.g., .1147)

B. For each of these options, compute the firms total residual income.

C. Suppose your performance is being evaluated based on return on investment. Which option would you choose and why?

D. Suppose your performance is being evaluation based on residual income? Which option would you choose and why?

E. Suppose corporate headquarters requires that all investments now earn at least a 14% return. What impact will this have on the options under consideration? What is your recommendation to management? Provide support for your answers.