Sylvia Zang is president of the Wilson Division of Performance Technologies, a multinational conglomerate. Zang manages $
Question:
Currently, Zang is considering two new investment opportunities: Project A and Project B. She can accept one or the other, or both, or neither. Each project, A and B, has a risk profile that differs from that of her existing portfolio of assets. Project A (with a risk- adjusted cost of capital of 15 percent) requires her purchasing new assets for $ 25 million that will generate EBI of $ 3.5 million. Project B (with a risk- adjusted cost of capital of 9 percent) requires her purchasing new assets for $ 30 million that will generate EBI of $ 3 million. Assume there are no synergies between Wilson’s existing assets and either project A and B and there are no synergies between project A and project B.
Required:
a. Assuming that Zang is rewarded based on improving the ROA of the Wilson Division, will she accept or reject projects A and B? Support your answer with detailed computations.
b. Instead of basing divisional managers’ bonuses on ROA, Performance Technologies switches to residual income as the methodology used to measure divisional performance and reward divisional managers, including Ms. Zang. Assuming that Zang is rewarded based on improving the residual income of the Wilson Division, what decision(s) will she make regarding accepting or rejecting projects A and B? Support your answer with detailed computations.
c. Discuss why your answers differ or are the same in parts (a) and (b).
d. Should Performance Technologies use ROA or residual income to evaluate and reward division managers? Justify your recommendation with sound logical analysis.
Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Portfolio
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Related Book For
Accounting for Decision Making and Control
ISBN: 978-0078025747
8th edition
Authors: Jerold Zimmerman
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