A Division Within a Firm Has an Average Return on Assets

question 78

Multiple Choice

A division within a firm has an average return on assets employed of 12% and is considering purchasing a new asset.The new asset is expected to generate cash flows of $17,000 per year for the next seven years but these have a beta coefficient of 1.3 compared to the portfolio return on the other assets in the division.The risk free rate of return is 2%; the weighted average cost of capital is 9%; and, the cost of the new asset is $170,000.
-If the division manager's bonus depends on division ROI will she be likely to purchase the asset?

• A)Yes, because ROI is greater than the division average return on assets employed.
• B)No, because the ROI is less than the division average return on assets employed.
• C)No, because the ROI is less than both the division average return on assets employed and the weighted average cost of capital.
• D)Yes, because the ROI is greater than both the division average return on assets employed and the weighted average cost of capital.
• E)Yes, because the net present value is positive when basing the discount rate on the weighted average cost of capital minus the risk free rate of return.

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