Question - Kashmir Products is a division of Oberlin Textiles, Inc. During the coming year, it expects to earn a net operating income of $290,000 based on sales of $3.45 million; without any new investments, the division will have average net operating assets of $3 million.
The division is considering a capital investment project-adding knitting machines to produce socks-that requires an additional investment of $600,000 and increases net operating income by $57,500 (sales would increase by $575,000). If made, the investment would increase beginning net operating assets by $600,000 and ending net operating assets by $400,000. Assume that the minimum rate of return required by the company is 7 percent.
Required:
1. Compute the ROI for the division without the investment.
2. Compute the margin and turnover ratios without the investment. Show that the product of the margin and turnover ratios equals the ROI computed in Requirement 1.
3. Compute the ROI for the division with the new investment. Do you think the divisional manager will approve the investment? Explain. (Note: Be sure to use average operating assets in your calculation.)
4. Compute the margin and turnover ratios for the division with the new investment. Compare these with the old ratios.
5. Assume that a JIT purchasing and manufacturing system is installed, reducing average operating assets by $800,000. Compute the ROI with and without the investment under this new scenario. Now do you think the divisional manager will accept the new investment? Should he accept it? Explain you answer.
6. Assume that the JIT purchasing and manufacturing system is installed, reducing average operating assets by $800,000. Now assume that the divisional manager is evaluated with residual income. Compute the residual income with and without the investment under this new scenario. Now do you think the divisional manager will accept the new investment? Should he accept it? Explain you answer.