1.1 (10 marks) Performance evaluation Chapter 11

Janson Inc., is a large, integrated German conglomerate with shipping, metals, and mining operations throughout Europe. The general manager of the mining division plans to submit a proposed capital budget for 2022 for inclusion in the companywide budget.

The division manager is considering the following projects, all of which require an outlay of capital. All projects have equal risk.

Project	Investment Required	Return
1	$4,800,000	$1,200,000
2	1,900,000	627,000
3	1,400,000	182,000
4	950,000	152,000
5	650,000	136,500
6	300,000	90,000

The division manager must decide which of the projects to take. The company has a cost of capital of 15 percent. An amount of $12 million is available to the division for investment purposes.

Required:

1. What will be the total investment, total return, return of capital invested (ROI), and residual income (RI) of the Mining division manager if:

1. The company has a rule that managers should accept all projects promising a return on investment of at least 20 percent.
2. The company evaluates division managers on their ability to maximize the return on capital invested or ROI (assume that this is a new division with no invested capital).
3. The division manager is expected to maximize residual income (RI) computed by using the 15 percent cost of capital.

2. Which of the three approaches (a) i, ii, or iii) will induce the most effective investment policy for the company as a whole? Explain.