Sally Omar is the manager of the office products division of Wallace Enterprises. In this position, her annual bonus is based on an appraisal of return on investment (ROl) measured as Division Income + End-of-Year Division Assets (net of accumulated depreciation).
Currently, Sally is considering investing $30,000,000 in modernization of the division plant in Tennessee. She estimates that the project will generate cash savings of $6,000,000 per year for eight years. The plant improvements will be depreciated over eight years ($30,000,000 ÷8 years = $3,750,000).Thus, the annual effect on income will be $2,250,000 ($6,000,000 — $3,750,000).

Using a discount rate of 10 percent. Calculate the NPV of the modernization project. Then calculate the ROl of the project each year over its eight-year life. (Calculate ROl as effect on income divided by end-of-year book value. Note that the value of ROl is not defined at the end of year when book value is zero.) Finally, write a paragraph explaining why Sally may not make the investment even though it has a positive NPV.

  • CreatedSeptember 23, 2013
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