Paula Booth, president of ABC Corp., is ordering that any project undertaken by the company must earn a minimum return of 10%. Given the company's centralization, Paula leaves all investment decisions to the divisional managers as long as they anticipate a minimum return of at least 10%. The manager of DEF division, Martin Koch, has achieved a 14% return on investment for the past three years. This year is not expected to be different from the past three years. Koch has just received a proposal to invest $1,800,000 in a new product line that is expected to generate $216,000 in operating income.
1) Calculate the return on investment expected on the new product line.
2) If Martin Koch is evaluated based on the division's return on investment, will he choose to invest in the new line? You must explain your answer - a yes/no answer is not sufficient.
3) Explain why Paula Booth would/would not prefer that Martin Koch invest in the new line. You must fully explain your answer.
4) Calculate the residual income for the proposed new product line.
5) If Martin Koch is evaluated based on residual income, will he choose to invest in the new product line? You must explain your answer - a yes/no answer is not sufficient.