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An auto parts Company produces various extra additions to motor cars. It has just discovered...

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Accounting

An auto parts Company produces various extra additions to motor cars. It has just discovered an opportunity to invest in producing air conditioners for the back seats of vans and minibuses. The investment project will cost $925,000 and will generate an estimated additional operating income of $95,500.

Without the investment, the company will have average assets for the coming year of $29.5 million and expected operating income of $4.535 million.

Required:

  1. What is the ROI of the new investment project alone? Is it higher or lower than the existing ROI of the company?

  1. What will be the ROI of the company after accepting the new investment?

  1. Assuming that the managers are evaluated and rewarded on the basis of ROI performance, should a rational manger make the new investment? Why?

  1. Suppose that the company sets a minimum required rate of return to 11%. What will be the Residual Income of the company after accepting the new investment? Is it higher or lower than the Residual Income without the investment?

  1. What will be the Economic value Added (EVA) of the company after making the new investment if corporate tax rate is 30% and the actual cost of capital of the company is 10%?

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