Wendell Division has operating income of $40,000 for the year ending December 31,2011.Average invested capital is $800,000 and the weighted-average cost of capital is 10%.The division is considering a new investment that would cost $800,000 and earn 7% annually.If economic profit is the performance metric,should the manager of the Wendell Division accept the new investment?
A) No, because the return on investment of the division decreases with the new investment.
B) No, because the economic profit for the investment is negative.
C) Yes, because the economic profit for the investment is positive.
D) Yes, because the return on investment of the division increases with the new investment.

Question

Quizplus · Accepted Answer

The economic profit is calculated as the operating income minus the product of the average invested capital and the weighted-average cost of capital. For the new investment, the expected return is 7% on $800,000, which is $56,000. However, the cost of capital for this investment is 10% of $800,000, which is $80,000. Therefore, the economic profit would be $56,000 - $80,000 = -$24,000, indicating a negative economic profit.

Wendell Division Has Operating Income of $40,000 for the Year