Jacob Kemp was torn between conflicting emotions. On the one hand, things were going so well. He had just completed six months as the assistant financial manager in the Electronics Division of Med-Products Inc. The pay was good, he enjoyed his coworkers, and he felt that he was part of a team that was making a difference in American health care. On the other hand, his latest assignment was causing some sleepless nights. Max Cravens, his boss, had asked him to "refine" the figures on the division's latest project-a portable imaging device code-named ZM. The original estimates called for investment of $11.7 million and projected annual income of $1.4 million. Med-Products required an ROI of at least
15 percent for new project approval. So far, ZM's rate of return was nowhere near that hurdle rate. Max encouraged him to show increased sales and decreased expenses in order to get the projected income above $1.76 million. Jacob asked for a meeting with Max to voice his concerns.
Jacob: Max, I've gone over the figures for the new project and can't find any way to get the income above $1.4 million. The salespeople have given me the most likely revenue figures, and production feels that the expense figures are solid.
Max: Jacob, those figures are just projections. Sales doesn't really know what the revenue will be. In fact, when I talked with Sara Harris, our sales vice president, she said that sales could range from $1.1 million to $1.9 million. Use the higher figure. I'm sure this product will justify our confidence in it!
Jacob: I know the range of sales was that broad, but Sara felt the $1.9 million estimate was pretty unlikely. She thought that during the first five years or so that ZM sales would stay in the lower end of the range.
Max: Again, Sara doesn't know for sure. She's just estimating. Let's go with the higher estimate. We really need this product to expand our line and to give our division a chance to qualify for sales-based bonuses. If ZM sells at all, our revenue will go up, and we'll all share in the bonus pool!
Jacob: I don't know, Max. I feel pretty bad signing off on ROI projections that I have so little confidence in.
Max: (frustrated) Look, Jacob, just prepare the report. I'll back you up. ROI and Decision Making
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What is the ROI of project ZM based on the initial estimates? What would ROI be if the income rose to $1.76 million? Use the format provided in Appendix A on page 3 for your calculations (rounded to two decimal places).