Paula Boothe, president of the Indigo Corporation, has mandated a minimum 9% ret

Question

Paula Boothe, president of the Indigo 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 9%. 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 $1,927,000 in a new line of energy drinks that is expected to generate $237,300 in operating income.

Paula Boothe, president of the Indigo 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 9%. 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 $1,927,000 in a new line of energy drinks that is expected to generate $237,300 in operating income.

Explanation / Answer

answer 1. Residual Income = $237,300 - ($1,927,000 X 9%) Residual Income = $237,300 - $173,430 Residual Income = $63,870 Answer 2. Yes, Martin Koch will accept the proposal based on residual income as it yields more than the required rate of return.

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