Exercise 10.8 ROl and Investment Decisions Refer to Exercise 10.7 for data. At the end of Year 2, the manager of the Houseware Division is concerned about the division's performance. As a result, he is considering the opportunity to invest in two independent projects. The first is called the Espresso-Pro; it is an in-home espresso maker that can brew regular coffee as well as make espresso and latte drinks. While the market for espresso drinkers is small initially, he believes this market can grow, especially around gift- giving occasions. The second is the Mini-Prep appliance that can be used to do small chopping and dicing chores that do not require a full-sized food processor. Without the investments, the division expects that Year 2 data will remain unchanged. The expected operating incomes and the outlay required for each investment are as follows: Espresso-Pro Mini-Prep Operating income Outlay S 27,500 250,000 S 19,000 200,000 Jarriot's corporate headquarters has made available up to $500,000 of capital for this divi- sion. Any funds not invested by the division will be retained by headquarters and invested to earn the company's minimum required rate of return, 9 percent. Required: 1. Compute the ROI for each investment. 2. Compute the divisional ROI (rounded to four significant digits) for each of the following four alternatives: a. The Espresso-Pro is added. b. The Mini-Prep is added. c. Both investments are added. d. Neither investment is made; the status quo is maintained. Assuming that divisional managers are evaluated and rewarded on the basis of ROI performance, which alternative do you think the divisional manager will choose?
Exercise 10.8 ROl and Investment Decisions Refer to Exercise 10.7 for data. At the end of Year 2, the manager of the Houseware Division is concerned about the division's performance. As a result, he is considering the opportunity to invest in two independent projects. The first is called the Espresso-Pro; it is an in-home espresso maker that can brew regular coffee as well as make espresso and latte drinks. While the market for espresso drinkers is small initially, he believes this market can grow, especially around gift- giving occasions. The second is the Mini-Prep appliance that can be used to do small chopping and dicing chores that do not require a full-sized food processor. Without the investments, the division expects that Year 2 data will remain unchanged. The expected operating incomes and the outlay required for each investment are as follows: Espresso-Pro Mini-Prep Operating income Outlay S 27,500 250,000 S 19,000 200,000 Jarriot's corporate headquarters has made available up to $500,000 of capital for this divi- sion. Any funds not invested by the division will be retained by headquarters and invested to earn the company's minimum required rate of return, 9 percent. Required: 1. Compute the ROI for each investment. 2. Compute the divisional ROI (rounded to four significant digits) for each of the following four alternatives: a. The Espresso-Pro is added. b. The Mini-Prep is added. c. Both investments are added. d. Neither investment is made; the status quo is maintained. Assuming that divisional managers are evaluated and rewarded on the basis of ROI performance, which alternative do you think the divisional manager will choose?
Chapter1: Financial Statements And Business Decisions
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Transcribed Image Text:Exercise 10.8 ROl and Investment Decisions
Refer to Exercise 10.7 for data. At the end of Year 2, the manager of the Houseware Division is
concerned about the division's performance. As a result, he is considering the opportunity to
invest in two independent projects. The first is called the Espresso-Pro; it is an in-home espresso
maker that can brew regular coffee as well as make espresso and latte drinks. While the market
for espresso drinkers is small initially, he believes this market can grow, especially around gift-
giving occasions. The second is the Mini-Prep appliance that can be used to do small chopping
and dicing chores that do not require a full-sized food processor. Without the investments, the
division expects that Year 2 data will remain unchanged. The expected operating incomes and
the outlay required for each investment are as follows:
Espresso-Pro
Mini-Prep
Operating income
Outlay
S 27,500
250,000
S 19,000
200,000
Jarriot's corporate headquarters has made available up to $500,000 of capital for this divi-
sion. Any funds not invested by the division will be retained by headquarters and invested to
earn the company's minimum required rate of return, 9 percent.
Required:
1. Compute the ROI for each investment.
2. Compute the divisional ROI (rounded to four significant digits) for each of the following
four alternatives:
a. The Espresso-Pro is added.
b. The Mini-Prep is added.
c. Both investments are added.
d. Neither investment is made; the status quo is maintained.
Assuming that divisional managers are evaluated and rewarded on the basis of ROI
performance, which alternative do you think the divisional manager will choose?
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