Exercise D10-18 Paula Boothe, president of the Armange Corporation, has mandated

Question

Exercise D10-18 Paula Boothe, president of the Armange Corporation, has mandated a minimum 10% return on investment for any project undertaken by the company. Given the company's decentralization, Paula leaves all investment decisions to the divisional managers as long as they anticipate a minimum rate of return of at least 10%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 14% return on investment for the past three years. This year is not expected to be different from the past three. Koch has just received a proposal to invest $1,800,000 in a new line of energy drinks that is expected to generate $216,000 in operating income. Assume that Armange Corporation's actual weighted-average cost of capital is 9% and its tax rate is 30% Calculate the economic value added of the proposed new line of energy drinks. (If the economic value added is negative then enter with a negative sign preceding the number e.g.-5,125 or parenthesis. e.g. (5,125). Round answer to O decimal places, e.g 5,125.) Economic value added If Martin Koch is evaluated based on economic value added, will he choose to invest in the new line of energy drinks? Click if you would like to Show Work for this question:

Explanation / Answer

Economic value added=Operating income after taxes -(invested capital* weighted average cost of capital)

=216000*(1-30%)-1800000*9%=$-10,800

No, It should not invest as EVA is negative. It is not doing any value add.

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