Isabelle Abiassi operates a popular summer camp for elementary school children.

Question

Isabelle Abiassi operates a popular summer camp for elementary school children. Projections for the current year are as follows: Sales revenue Operating income $700,000 Average assets $4,000,000 The camp's weighted-average cost of capital is 10%, and Isabelle requires that all new investments generate a return on investment of at least 14%. The camp's current $8,000,000 tax rate is 25% At last week's advisory board meeting, Isabelle told the board that she had up to $50,000 to invest in new facilities at the camp and asked them to recommend some projects. Today the board's president presented Isabelle with the following list of three potential investments to improve the camp facilities Swimming Incremental operating income Average total assets Playground $3,500 25,000 Pool $4,800 40,000 Gym $ 2,700 15,000 Calculate the return on investment, residual income, and economic value added for each of the three projects. (Enter negative amounts using either a negative sign preceding the number e.g.-45 or parentheses e.g. (45). Round Economic Value Added answer to 2 decimal places, e.g. 15.25 & all other answers to decimal places, e.g.15 or 15%.) Playground Pool Gym Return on Investment Residual Income Economic Value Added

Explanation / Answer

PLAYGROUND

1.Return on investment

=Incremental operating income / Average total assets

=$3500 / $25000

=14%

2.Residual Income

= $3500 – ($25000*14%)

=$3500 - $3500

= 0

3.Economic Value Added

=($3500*75%) – ($25000*10%)

= $2625 - $2500

= $125

SWIMMING POOL

1.Return on investment

=Incremental operating income / Average total assets

=$4800 / $40000

=12%

2.Residual Income

= $4800 – ($40000*14%)

=$4800 - $5600

= ($800)

3.Economic Value Added

=($4800*75%) – ($40000*10%)

= $3600 - $4000

= ($400)

GYM

1.Return on investment

=Incremental operating income / Average total assets

=$2700 / $15000

=18%

2.Residual Income

= $2700 – ($15000*14%)

=$2700 - $2100

= $600

3.Economic Value Added

=($2700*75%) – ($15000*10%)

= $2025 - $1500

= $525

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