Paula Boothe, president of the Sheffield Corporation, has mandated a minimum 12%
ID: 2580288 • Letter: P
Question
Paula Boothe, president of the Sheffield Corporation, has mandated a minimum 12% 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 12%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 12% 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 $1,830,000 in a new line of energy drinks that is expected to generate $232,000 in operating income. Assume that Sheffield Corporation’s actual weighted-average cost of capital is 9% and its tax rate is 32%.
(a)
Paula Boothe, president of the Sheffield Corporation, has mandated a minimum 12% 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 12%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 12% 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 $1,830,000 in a new line of energy drinks that is expected to generate $232,000 in operating income. Assume that Sheffield Corporation’s actual weighted-average cost of capital is 9% and its tax rate is 32%.
Explanation / Answer
Economic value added (EVA) = Net Operating Profit After Tax - (Capital Invested x WACC) Net Operating = $232000 Tax rate = 32% Capital invested = $1830000 WACC = 9% EVA = $232000*(1-0.32) - ($1830000*9%) = $157760 - $164700 = -$6940