Return on Investment for Multiple Investments, Residual Income

The manager of a division that produces add-on products for the automobile industry has just been presented the opportunity to invest in two independent projects. The first is an air conditioner for the back seats of vans and minivans. The second is a turbocharger. Without the investments, the division will have average assets for the coming year of $29.9 million and expected operating income of $4.335 million. The outlay required for each investment and the expected operating incomes are as follows:

	Air conditioner		Turbocharger
Outlay	$950,000		$540,000
Operating income	90,000		82,080

Required:

1. Compute the ROI for each investment project. Round to the nearest whole percent.

Air conditioner, ROI	fill in the blank 1 %
Turbocharger, ROI	fill in the blank 2 %

2. Compute the budgeted divisional ROI for each of the following four alternatives. Round to two decimal places.

a. The air conditioner investment is made.	fill in the blank 3 %
b. The turbocharger investment is made.	fill in the blank 4 %
c. Both investments are made.	fill in the blank 5 %
d. Neither additional investment is made.	fill in the blank 6 %

3. Conceptual Connection: Assuming that divisional managers are evaluated and rewarded on the basis of ROI performance, which alternative do you think the divisional manager will choose?

The manager will choose the air conditioner, but not the turbocharger.The manager will choose both investments.The manager will choose the turbocharger, but not the air conditioner.

4. Conceptual Connection: Suppose that the company sets a minimum required rate of return equal to 14%. Calculate the residual income for each of the following four alternatives:

a. The air conditioner investment is made.	$fill in the blank 8
b. The turbocharger investment is made.	$fill in the blank 9
c. Both investments are made.	$fill in the blank 10
d. Neither additional investment is made.	$fill in the blank 11

Which option will the manager choose based on residual income?

The air conditionerThe turbochargerBoth alternatives are equally profitableImpossible to answer without additional information

5. Conceptual Connection: Suppose that the company sets a minimum required rate of return equal to 10%. Calculate the residual income for each of the following four alternatives:

a. The air conditioner investment is made.	$fill in the blank 13
b. The turbocharger investment is made.	$fill in the blank 14
c. Both investments are made.	$fill in the blank 15
d. Neither additional investment is made.	$fill in the blank 16

Based on residual income, which is the most profitable?