Consider the following information about a potential project: Investment require

Question

Consider the following information about a potential project:

Investment   required

$4,000,000

Expected   annual project revenue

$7,200,000

Expected   annual project expenses

$6,600,000

Required   rate of return

12%

Current   division return on investment

17%

a) Calculate the project

  

Investment   required

     

$4,000,000

     

Expected   annual project revenue

     

$7,200,000

     

Expected   annual project expenses

     

$6,600,000

     

Required   rate of return

     

12%

     

Current   division return on investment

     

17%

   Consider the following information about a potential project: Calculate the project's return on investment. Based solely on ROI, is this project in the firm's best interests? Why or why not? Is this project in the division manager's best interests? Why or why not? Perform DuPont Analysis on this project. What is the project's residual income?

Explanation / Answer

Hi,

Please find the answers as follows:

Part A:

Project's Return on Investment = Expected Annual Return/Investment*100

Expected Annual Return = Expected annual project revenue - Expected annual project expenses = 7200000 - 6600000 = 600000

Project's Return on Investment = 600000/4000000*100 = 15%

Part B:

Based solely on ROI, this project is in the firm's best interest. It is so because the return on investment (15%) is greater than the required rate of return (12%).

Part C:

No, this project is not in the best interest of the division's manager as ROI (15%) is less than the current division's return on investment.

Part D:
Dupont Analysis = Profit Margin*Asset Turnover*Equity Multiplier

Dupont Analysis = 600000/7200000*7200000/4000000*1 = 15%

Part E:

Residual Income = Net Income - Minimum Required Return

Residual Income = 600000 - 4000000*.12 = 120000

Thanks.

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