Textbook Problem

Return on Investment and Economic Value Added Calculations with Varying Assumptions

Knitpix Products is a division of Parker Textiles Inc. During the coming year, it expects to earn income of $310,000 based on sales of $3.45 million. Without any new investments, the division will have average operating assets of $3 million. The division is considering a capital investment project—adding knitting machines to produce gaiters—that requires an additional investment of $600,000 and increases net income by $57,500 (sales would increase by $575,000). If made, the investment would increase beginning operating assets by $600,000 and ending operating assets by $400,000. Assume that the actual cost of capital for the company is 7%. (Note: Round all answers to four decimal places.)

Required:

1. 1. Compute the ROI for the division without the investment.
2. 2. Compute the margin and turnover ratios without the investment. Show that the product of the margin and turnover ratios equals the ROI computed in Requirement 1.
3. 3. CONCEPTUAL CONNECTION Compute the ROI for the division with the new investment. Do you think the divisional manager will approve the investment?
4. 4. CONCEPTUAL CONNECTION Compute the margin and turnover ratios for the division with the new investment. How do these compare with the old ratios?
5. 5. CONCEPTUAL CONNECTION Compute the EVA of the division with and without the investment. Should the manager decide to make the knitting machine investment?