Response to the following problem:
As one of the division managers for Premier Inc., your performance is evaluated primarily on a single measure: after-tax divisional segment income less the cost of capital invested in divisional assets. The fair value of invested capital in your division is $20,000,000, the required return on capital is 10 percent, and the tax rate is 40 percent. Income projections for 2010 follow.
Sales ..........................................$ 30,000,000
Expenses .................................... (26,250,000)
Segment income ........................... $ 3,750,000
Taxes ......................................... (1,500,000)
After-tax segment income ................. $ 2,250,000
You are considering an investment in a new product line that would, according to projections, increase 2010 pre-tax segment income by $600,000. The investment cost is not yet determinable because negotiations about several factors are still under way.
a. Ignoring the new investment, what is your projected EVA for 2010?
b. In light of your answer in (a), what is the maximum amount that you would be willing to invest in the new product line?
c. Assuming that the new product line would require an investment of $3,100,000, what would be the revised projected EVA for your division in 2010 if the investment were made?