Moneygall Group PLC is a divisionalised company. Tom Birr is employed as the manager of one of the company's division. He is considering whether the division should undertake a new investment project. This project would have a three-year life and would give rise to the following operating cash flows (all of which would arise at the end of the year to which they relate): 

Sales: 

Year 1: Year 2: Year 3: 

€220,000 €240,000 €290,000 

Variable costs: 75% of sales revenues.

 Fixed costs other than depreciation: €29,000 per annum. 

To undertake the project, the division would make an immediate investment of €75,000 in tangible fixed assets plus a further €36,000 in working capital. The tangible fixed assets would be depreciated on a straight-line basis over the life of the project and would have a nil residual value at the end of that time. The working capital investment would be recovered in full at the end of the project. 

The cost of capital in this division 5% and (at this cost of capital) the project has a positive net present value of €10,555. 

Tom's performance is measured each year on the basis of the Residual Income earned by his division. In the Residual Income calculation, "investment" in the division is measured as the total investment (working capital plus the net book value of tangible fixed assets) at the beginning of the year.

Required: 

1. (i) Determine the Residual Income of the project in each of the three years of its life
2. (ii) Would it be goal congruent for Tom to accept the proposed investment project? Justify your answer.
3. Also, critically evaluate whether Tom is likely to accept the proposed investment and indicate what additional information would enable you to answer this question with greater certainty.

Answer rating: 100% (QA)

i To determine the Residual Income RI of the project in each of the three years we need to calculate the net operating income and deduct the cost of c... View the full answer