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# Melbourne Co ROI or Economic profits; P10-32 unknowns

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Problem 10-32

Finding unknowns

Consider the following data:

Division
J K L
Income \$280,000 \$ \$
Revenue \$ \$ \$
Invested Capital \$ \$3,000,000 \$ 16,000,000
Return on sales 7% 4% %
Capital turnover 4 3
Rate of return on invested capital % 20% 15%
Cost of capital 16% 12% %
Economic profit \$ \$ \$320,000

1. Prepare a similar tabular presentation, filling in all blanks
2. Which division is the best performer? Explain

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Chapter 10

10:B1 - ROI or Economic profit

Melbourne Co. is a large integrated Australian conglomerate with shipping, metals and mining operations throughout Asia. Melbourne is just starting a new manufacturing division and the newly appointed general manager plans to submit a proposed capital budget for 20X8 for inclusion in the companywide budget.

The division manager has for consideration 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
5 650,000 136,000
6 300,000 90,000

The division manager must decide which of the projects to take. The company has a cost of capital of 20%. An amount of \$12 million is available to the division for investment purposes.

1. What will be the total investment, total return, return on capital invested and economic profit of the rational division manager if

a. The company has a rule that managers should accept all projects promising a return on investment of at least 15%?
b. The company evaluates division managers on their ability to maximize the return on capital invested (assume this is a new division so that invested capital will consist only of capital invested in new projects adopted by the managers)?
c. The division manager is expected to maximize economic profit computed using 20% cost of capital?
2. Which of the three approaches will induce the most effective investment policy for the company as a whole? Explain

#### Solution Preview

Your tutorial is in Excel (attached). See separate tabs for each problem. ...

#### Solution Summary

Your tutorial is in Excel (attached). See separate tabs for each problem.

Your discussion is 204 words to interpret the computations. The tutorial shows three schedules to support the analysis and assistance with solving the missing blanks.

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