ROI and Residual Income
Response to the following problem:
The manager of the manufacturing division of Minolta Company is evaluated on a residual income basis. He is in the process of evaluating three investment proposals.
a. Pay $500,000 for a new machine that will increase production substantially. This will result in an increased income of $80,000 annually.
b. Pay $350,000 for a new machine that will reduce labor costs by $70,000 annually.
c. Pay $800,000 for a new machine that will increase annual operating profit by $115,000.
The manufacturing division currently has total assets of $1.2 million and operating profit of $200,000. Its minimum accepted rate of return is 15%.
Required:
1. Evaluate the three investment proposals independently, and determine which should be accepted.
2. Assuming that the division manager is evaluated on the basis of the division's ROI, determine whether each of the proposals should be accepted or rejected.