Question 2 Investment Center Evaluation (ROI, RI, EVA)

Daniel is a division manager at a company that has a required rate of return of 8% for its divisions. As manager, Daniel is evaluated on his business units ability to generate at least an 8% return and to take on new projects with expected returns of 8% and higher, with bonuses based on how much ROI is earned. Daniel is considering the following project:

Investment in PP&E $10,000 Expected sales $2,577 Expected operating expenses $1,700

Calculate the prospective ROI for this project, using the DuPont method (profit margin, investment turnover, ROI), interpret each ratio. Compute the residual income and economic value added. Will the project be accepted?

Compute this investments expected residual income using the following information.

Investment in PP&E $10,000

Expected operating income tied to that asset $887

Companys required rate of return 8%

Compute the EVA ratio using the following information:

Invested capital (divisional assets net of current liabilities) $10,000

Expected operating income tied to that asset $877

Companys required rate of return 8%

Tax rate 24%

Proportion of debt 75%

Proportion of equity 25%

Cost of debt 6%

Cost of equity 8%