Use the following information in answering question 1 through 7.
Management of Willis Company's Satellite Entertainment Division is considering investing in each of the three following projects. Available resources would allow management to select none, any, or all, of the projects if they found them worth the investment. The current after-tax ROI of the Satellite Entertainment Division using average net book value of assets is 18 percent and the division's target ROI is 15 percent Willis Company's tax rate is 40 percent.
| Project |
Year One Sales |
Year One Before tax Income |
Cost of Investment |
Useful Life |
Salvage Value |
| 1 |
$1,800,000 |
$464,500 |
$2,500,000 |
4 years |
$100,000 |
| 2 |
$1,400,000 |
$390,000 |
$1,600,000 |
5 years |
$0 |
| 3 |
$1,200,000 |
$360,000 |
$3,000,000 |
4 years |
$0 |
1. Calculate the before tax margin percentage associated with Project 1.
2. What is the year one ROl associated with Project One based on average gross book value of assets and before-tax income?
3. Calculate the year one residual income for Project 2 using average net book value of assets and after tax income.
4. Calculate the year one ROI for each of the three projects using average net book value of assets and after tax income.
5. If the division manager is evaluated based on maintaining or improving ROl using average net book value of assets and after-tax income, which of the above projects would he/she be inclined to accept? Explain the rationale for your answer.
6. If the division manager were evaluated on residual income based on average net book value of the assets and after tax income, which of the projects would he/she he inclined to accept? Explain the rationale for your answer.
7. Which of the projects are clearly good for the firm? Explain the rationale for your answer.