Reference no: EM133041823
Question - Beverly Company has two divisions: Division A and Division B.
Managers of both divisions have decision-making rights and responsibilities for long-term investment decisions.
The following represents operating results for each of the divisions for FY 2020:
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Division A
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Division B
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Revenues
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$25,000
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$14,000
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Variable Costs
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$12,500
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$6,000
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Fixed Costs
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$9,000
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$2,000
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Net assets
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$30,000
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$30,600
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Suppose that at the beginning of 2021, the Division A manager and Division B manager are considering an opportunity that requires a $4,000 investment to earn $600 in additional income.
The two-division managers can each make an investment in this opportunity separately and independently of one another.
The firm has estimated its cost of capital at 12%.
The CEO of Beverly Company (a lovely person, by the way) recalls the following: Two important performance measures reflect the effective and efficient use of assets (i.e., investments). One of these measures potentially creates the "underinvestment problem." The other of these measures help reduce/eliminate the underinvestment problem.
Required - Calculate the value of the performance measure that helps reduce/eliminate a potential underinvestment problem for Division A. (Note: Answer this question regardless of whether the underinvestment problem actually occurs.)