Question: XPE is a division of Cavendish, Inc., treated as an investment center. The manager is evaluated on ROI. ROI for Cavendish as a whole is 12%, which is the minimum expected return on new investment. Currently, XPE has been producing net income of $1,200,000 on assets of $7,000,000. There is an opportunity to acquire an existing business for $1,000,000, which will produce net income of $135,000 annually.
a. Will the manager of XPE be inclined to accept or refuse this opportunity. Explain, with supporting calculations.
b. If instead the manager is evaluated on residual income, would she be inclined to accept or refuse? Explain.
c. Comment briefly on what this example illustrates about how investment centers should be evaluated.