Lounsbury Parts has a current return on investment of 10% and the company has established an 8% minimum rate of return for the division. The division manager has two investment projects available, for which the following estimates have been made:
Project A - Annual controllable margin = $24,000, operating assets = $400,000
Project B - Annual controllable margin = $60,000, operating assets = $550,000
Which project should be funded?
A) Both projects
B) Project A
C) Project B
D) Neither project

Question

Quizplus · Accepted Answer

To determine if an investment project should be funded, the ROI of the project must be compared to the minimum rate of return established by the company.

For Project A: 
ROI = Annual controllable margin / Operating assets 
ROI = $24,000 / $400,000 
ROI = 0.06 or 6%

Since the ROI of Project A is less than the 8% minimum rate of return, it should not be funded.

For Project B: 
ROI = Annual controllable margin / Operating assets 
ROI = $60,000 / $550,000 
ROI = 0.1091 or 10.91%.

Since the ROI of Project B is greater than the 8% minimum rate of return, it should be funded.

Therefore, the best choice is to fund Project B.

Lounsbury Parts Has a Current Return on Investment of 10