Paula Boothe, president of the Concord Corporation, has mandated a minimum 8% re
ID: 2580464 • Letter: P
Question
Paula Boothe, president of the Concord Corporation, has mandated a minimum 8% 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 8%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 15% 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 $1,897,000 in a new line of energy drinks that is expected to generate $234,200 in operating income.
a)Calculate the residual income for the proposed new line of energy drinks.
Explanation / Answer
year
Cash flows
DCF
15%
Present Value
Cash flows
DCF
8%
Present Value
RESIDUAL
INCOME
expected
Minimum requirement
Investment
0
(1897000)
1
(1897000)
1
Operating income
1
234200
.8696
203660
234200
.9259
216845
13185
2
234200
.7561
177079
234200
.8573
200780
23701
3
234200
.6575
153987
234200
.7938
185908
31921
NET PRESENT VALUE
534726
603533
68807
year
Cash flows
DCF
15%
Present Value
Cash flows
DCF
8%
Present Value
RESIDUAL
INCOME
expected
Minimum requirement
Investment
0
(1897000)
1
(1897000)
1
Operating income
1
234200
.8696
203660
234200
.9259
216845
13185
2
234200
.7561
177079
234200
.8573
200780
23701
3
234200
.6575
153987
234200
.7938
185908
31921
NET PRESENT VALUE
534726
603533
68807