Reference no: EM133042478
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 (i.e., investment)
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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 helps reduce/eliminate the underinvestment problem.
Required - Calculate the value of the performance measure that helps reduce/eliminate a potential underinvestment problem for Division A.