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 $7,380,000 Operating income $647,250 Average assets $3,696,000 The camp’s weighted-average cost of capital is 8%, and Isabelle requires that all new investments generate a return on investment of at least 11%. The camp’s current 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. Playground Swimming Pool Gym Incremental operating income $ 2,794 $ 3,384 $ 2,208 Average total assets 25,400 37,600 13,800 (a) 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 0 decimal places, e.g. 15 or 15%.) Playground Pool Gym Return on Investment % % % Residual Income $ $ $ Economic Value Added $ $ $

Explanation / Answer

1. return on investment = incremental operating income / average assets * 100

2794 / 25400 *100

= 11 %

3384 / 37600 *100

= 9 %

2208 / 13800 *100

= 16%

2. residual income = incremental operating income - required rate of return * average assets

2794 - .11* 25400

= $ 0

3384 - .11*37600

= ( $ 752)

2208 - .11*13800

=$ 690

3. economic value added = incremental operating income net of tax - weighted average cost of capital * average assets

  

2794(1-.25) - .08*25400

=2095.5 - 2032

= $ 63.5

3384 (1-.25) -.08 *37600

=2538 - 3008

=($ 470)

2208 (1-.25) - .08 *13800

=1656 - 1104

= $ 552

playground pool gym incremental operating income 2794 3384 2208 average assets 25400 37600 13800

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