Happy Hops Ltd. expects its divisions to earn a minimum rate of return of 13%. One of its divisions, India Pale Ales (IPA), is an investment centre that harvests, ferments and bottles various types of IPA beers.

An investment opportunity is available to the IPA division that would require an investment of $700,000 in new operating assets and would earn net operating income of $112,000.

Required:

a) Would the management of the IPA division likely accept the investment opportunity if they are evaluated based on return on investment of the division? Show calculations and conclude. (2 marks)

b) Would the management of the IPA division likely accept the investment opportunity if they are evaluated based on residual income? Show calculations and conclude. (3 marks)