Pronghorn Corporation

5.

Paula Boothe, president of the Pronghorn 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 10%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 13% 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 $2,000,000 in a new line of energy drinks that is expected to generate $240,000 in operating income.

(a)Calculate the return on investment expected on the new line of energy drinks.

6.Pharoah Decor sells home decor items through three distribution channels—retail stores, the Internet, and catalog sales. Each distribution channel is evaluated as an investment center. Selected results from the latest year are as follows:                                                         Retail Stores                        Internet                       Catalog Sales

Sales revenue                                    $9,420,000                  $3,550,000                       $3,465,000

Variable expenses                            3,925,000                      1,369,000                        1,800,000

Direct fixed expenses                    3,987,800                           911,875                        1,474,425

Average assets                                   7,850,000                       3,550,000                     1,925,000

Required rate of return                              12%                              12%                               12%

(a1)Calculate the margin and asset turnover for each of the three distribution channels.

(a2)Calculate the ROI for each of the three distribution channels.

8.

Sunland Decor sells home decor items through three distribution channels—retail stores, the Internet, and catalog sales. Each distribution channel is evaluated as an investment center. Selected results from the latest year are as follows:                                      Retail Stores                    Internet                    catalog Sales

Sales revenue                 $9,970,000                   $3,920,000                $3,100,000

Variable expenses          3,920,000                     1,470,000                  1,770,000

Direct fixed expenses      4,420,000                    970,000                     1,170,000

Average assets                 7,920,000                   3,920,000                    1,730,000

Required rate of return             11%                          11%                            11%

(a)Calculate the current residual income for each distribution channel.

(b)The corporate office is giving the managers of each channel the option of a customer relationship management system that will allow the managers to gather data about their customers and be more effective in their marketing efforts. The system will cost $770,000 and is expected to generate $152,000 in additional annual segment margin.Calculate the residual income of each distribution channel assuming it purchases the new customer relationship management system.

9

Paula Boothe, president of the Blue Corporation, has mandated a minimum 9% 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 11%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 14% 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 $1,839,000 in a new line of energy drinks that is expected to generate $333,000 in operating income. Assume that Blue Corporation’s actual weighted-average cost of capital is 11% and its tax rate is 30%.

(a)Calculate the economic value added of the proposed new line of energy drinks.