“E25.4 Sapsora Company uses ROI to measure the performance of its operating divisions and to reward
division managers. A summary of the annual
reports from two divisions is shown below. The companys
weighted-average cost of capital is 12
percent.

Division A
Division B
Total assets . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . $6,000,000 $8,750,000
Current liabilities . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . 500,000 1,750,000
After-tax operating income . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . 1,000,000 1,180,000
ROI . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . 25% 14%
a. Which division is more profitable?
b. Would EVA more clearly show the relative
contribution of the two divisions to the company as
a whole? Show the computations.
c. Suppose the manager of Division A was
offered a one-year project that would increase his
investment base by $250,000 and show a
profit of $37,500. Would the manager choose to
invest in the new project?
E25.5 An investment center in Shellforth
Corporation was asked to identify three proposals for its
capital budget. Details of those proposals
are:

Capital
Budget Proposals

A B C
Capital required . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . $80,000 $50,000 $150,000
Annual operating return . . . . . . . . . .
. . . . . . . . . . . . . . . . 24,000
16,000 15,000
Shellforth uses residual income to evaluate
all capital budgeting projects. Its minimum required
return is 12 percent.
a. Assume you are the investment center
manager. Which project do you prefer? Why?
b. Assume your investment centers current
ROI is 18 percent and that the president of Shellforth
is thinking about using ROI for the
investment centers evaluation. Would your preferences for
the projects listed above change? Why?
E25.6 Jennifer
Baskiter is president and CEO of Plants& More.com , an Internet company
that sells plants and flowers. The success of her startup Internet company has
motivated her to expand and create two divisions. One division focuses on sales
to the general public and the other focuses on
business-to-business
sales to hotels, restaurants, and other firms that want plants and flowers for
their businesses.
She is considering using return on investment as a means of evaluating her
divisions
and their
managers. She has hired you as a compensation consultant. What issues or
concerns
would you raise
regarding the use of ROI for evaluating the divisions and their managers?
E25.7 You are the
manager of the Midwest Region, a 27-restaurant division that is part of the
chain Bites and Bits. The restaurants offer casual dining and compete with
such chains in your region as
Olive Garden and
Outback Steakhouse . You receive an annual cash bonus of 5 percent of sales
when residual
income in your region exceeds the required minimum return on invested capital
of
15 percent. You
are using a similar performance evaluation plan to reward each of the managers
in
your 27
restaurants. You are concerned that important performance variables are being
overlooked. For example, you have heard complaints from other regions and in
your own region that the quality of the food is bad, it is difficult to retain
serving staff in the restaurants, and finding a good chef is very difficult.
At an upcoming
planning meeting for all regional directors, the agenda includes considering
the
business
performance evaluation and compensation plan. What could you say about the
current
compensation plan
and what would you propose to remedy the problems?
E26.8 Pack &
Carry is debating whether to invest in new equipment to manufacture a line of
high-quality luggage. The new equipment would cost $1,728,125, with an
estimated five-year life and no salvage value. The estimated annual operating
results with the new equipment are as follows:
Revenue from sales
of new luggage . . . . . . . . . . . . . . . . . . . . . . . . . . . $800,000
Expenses other
than depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$306,250
Depreciation
(straight-line basis) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. 345,625 651,875
Increase in net
income from the new line . . . . . . . . . . . . . . . . . . . . . . . $148,125
All revenue from
the new luggage line and all expenses (except depreciation) will be
received or paid
in cash in the same period as recognized for accounting purposes. You are
to compute the
following for the investment in the new equipment to produce the new luggage
line:
a. Annual cash
flows.
b. Payback period.
c. Return on
average investment.
d. Total present
value of the expected future annual cash inflows, discounted at an annual rate
of
10 percent.
e. Net present
value of the proposed investment discounted at 10 percent.

E26.9The division
managers of Chester Construction Corporation submit capital investment
proposals
each year for
evaluation at the corporate level. Typically, the total dollar amount requested
by the
divisional
managers far exceeds the companys capital investment budget. Thus, each
proposal is
first ranked by
its estimated net present value as a primary screening criterion.
Jeff Hensel, the
manager of Chesters commercial construction division, often overstates the
projected cash
flows associated with his proposals, and thereby inflates their net present
values. He
does so because,
in his words, Everybody else is doing it.
a. Assume that all
the division managers do overstate cash flow projections in their proposals.
What would you do
if you were recently promoted to division manager and had to compete for
funding under
these circumstances?
b. What controls
might be implemented to discourage the routine overstatement of capital
budgeting
estimates by the
division managers?
E26.10 EnterTech has noticed a significant
decrease in the profitability of its line of portable CD players.
The production manager believes that the
source of the trouble is old, inefficient equipment used
to manufacture the product. The issue
raised, therefore, is whether EnterTech should (1) buy new
equipment at a cost of $120,000 or (2)
continue using its present equipment.
It is unlikely that demand for these
portable CD players will extend beyond a five-year time
horizon. EnterTech estimates that both the
new equipment and the present equipment will have a
remaining useful life of five years and no
salvage value.
The new equipment is expected to produce
annual cash savings in manufacturing costs of
$34,000, before taking into consideration
depreciation and taxes. However, management does not
believe that the use of new equipment will
have any effect on sales volume. Thus, its decision rests
entirely on the magnitude of the potential
cost savings.
The old equipment has a book value of
$100,000. However, it can be sold for only $20,000 if it
is replaced. EnterTech has an average tax
rate of 40 percent and uses straight-line depreciation for
tax purposes. The company requires a
minimum return of 12 percent on all investments in plant
assets.
a. Compute the net present value of the new
machine using the tables in Exhibits 263
and 264.
b. What nonfinancial factors should
EnterTech consider?
c. If the manager of EnterTech is uncertain
about the accuracy of the cost savings estimate, what
actions could be taken to double-check the
estimate?E25.4 Sapsora Company uses ROI to measure
the performance of its operating divisions and to rewarddivision managers. A summary of the annual
reports from two divisions is shown below. The companysweighted-average cost of capital is 12
percent.
Division A
Division BTotal assets . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . $6,000,000 $8,750,000Current liabilities . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . 500,000 1,750,000After-tax operating income . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . 1,000,000 1,180,000ROI . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . 25% 14%a. Which division is more profitable?b. Would EVA more clearly show the relative
contribution of the two divisions to the company asa whole? Show the computations.c. Suppose the manager of Division A was
offered a one-year project that would increase hisinvestment base by $250,000 and show a
profit of $37,500. Would the manager choose toinvest in the new project?E25.5 An investment center in Shellforth
Corporation was asked to identify three proposals for its capital budget. Details of those proposals
are:
Capital
Budget Proposals
A B CCapital required . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . $80,000 $50,000 $150,000Annual operating return . . . . . . . . . .
. . . . . . . . . . . . . . . . 24,000
16,000 15,000Shellforth uses residual income to evaluate
all capital budgeting projects. Its minimum requiredreturn is 12 percent.a. Assume you are the investment center
manager. Which project do you prefer? Why?b. Assume your investment centers current
ROI is 18 percent and that the president of Shellforthis thinking about using ROI for the
investment centers evaluation. Would your preferences forthe projects listed above change? Why?E25.6 Jennifer
Baskiter is president and CEO of Plants& More.com , an Internet company
that sells plants and flowers. The success of her startup Internet company has
motivated her to expand and create two divisions. One division focuses on sales
to the general public and the other focuses onbusiness-to-business
sales to hotels, restaurants, and other firms that want plants and flowers fortheir businesses.
She is considering using return on investment as a means of evaluating her
divisionsand their
managers. She has hired you as a compensation consultant. What issues or
concernswould you raise
regarding the use of ROI for evaluating the divisions and their managers?E25.7 You are the
manager of the Midwest Region, a 27-restaurant division that is part of the
chain Bites and Bits. The restaurants offer casual dining and compete with
such chains in your region asOlive Garden and
Outback Steakhouse . You receive an annual cash bonus of 5 percent of saleswhen residual
income in your region exceeds the required minimum return on invested capital
of15 percent. You
are using a similar performance evaluation plan to reward each of the managers
inyour 27
restaurants. You are concerned that important performance variables are being
overlooked. For example, you have heard complaints from other regions and in
your own region that the quality of the food is bad, it is difficult to retain
serving staff in the restaurants, and finding a good chef is very difficult.At an upcoming
planning meeting for all regional directors, the agenda includes considering
thebusiness
performance evaluation and compensation plan. What could you say about the
currentcompensation plan
and what would you propose to remedy the problems?E26.8 Pack &
Carry is debating whether to invest in new equipment to manufacture a line of
high-quality luggage. The new equipment would cost $1,728,125, with an
estimated five-year life and no salvage value. The estimated annual operating
results with the new equipment are as follows:Revenue from sales
of new luggage . . . . . . . . . . . . . . . . . . . . . . . . . . . $800,000Expenses other
than depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$306,250Depreciation
(straight-line basis) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. 345,625 651,875Increase in net
income from the new line . . . . . . . . . . . . . . . . . . . . . . . $148,125All revenue from
the new luggage line and all expenses (except depreciation) will bereceived or paid
in cash in the same period as recognized for accounting purposes. You areto compute the
following for the investment in the new equipment to produce the new luggageline:a. Annual cash
flows.b. Payback period.c. Return on
average investment.d. Total present
value of the expected future annual cash inflows, discounted at an annual rate
of10 percent.e. Net present
value of the proposed investment discounted at 10 percent.E26.9The division
managers of Chester Construction Corporation submit capital investment
proposalseach year for
evaluation at the corporate level. Typically, the total dollar amount requested
by thedivisional
managers far exceeds the companys capital investment budget. Thus, each
proposal isfirst ranked by
its estimated net present value as a primary screening criterion.Jeff Hensel, the
manager of Chesters commercial construction division, often overstates theprojected cash
flows associated with his proposals, and thereby inflates their net present
values. Hedoes so because,
in his words, Everybody else is doing it.a. Assume that all
the division managers do overstate cash flow projections in their proposals.What would you do
if you were recently promoted to division manager and had to compete forfunding under
these circumstances?b. What controls
might be implemented to discourage the routine overstatement of capital
budgetingestimates by the
division managers?E26.10 EnterTech has noticed a significant
decrease in the profitability of its line of portable CD players.The production manager believes that the
source of the trouble is old, inefficient equipment usedto manufacture the product. The issue
raised, therefore, is whether EnterTech should (1) buy newequipment at a cost of $120,000 or (2)
continue using its present equipment.It is unlikely that demand for these
portable CD players will extend beyond a five-year timehorizon. EnterTech estimates that both the
new equipment and the present equipment will have aremaining useful life of five years and no
salvage value.The new equipment is expected to produce
annual cash savings in manufacturing costs of$34,000, before taking into consideration
depreciation and taxes. However, management does notbelieve that the use of new equipment will
have any effect on sales volume. Thus, its decision restsentirely on the magnitude of the potential
cost savings.The old equipment has a book value of
$100,000. However, it can be sold for only $20,000 if itis replaced. EnterTech has an average tax
rate of 40 percent and uses straight-line depreciation fortax purposes. The company requires a
minimum return of 12 percent on all investments in plantassets.a. Compute the net present value of the new
machine using the tables in Exhibits 263and 264.b. What nonfinancial factors should
EnterTech consider?c. If the manager of EnterTech is uncertain
about the accuracy of the cost savings estimate, whatactions could be taken to double-check the
estimate?”