Ashton Corporation recently announced a bonus plan to reward the manager of its

Question

Ashton Corporation recently announced a bonus plan to reward the manager of its most profitable division. The three divisional managers are to decide which performance measure will be used to evaluate profitability. Ashton Corporation requires a 10% minimum return on investment. The following information is available for the year just ended. Division Gross Book Value of Assets Divisional Operating Income Bristol $800,000 $94,960 Darden 752,300 91,620 Gregory 449,000 58,590 (a) Calculate return on investment. (Round ROI to 2 decimal places, e.g. 5.12%.) Return on Investment Bristol % Darden % Gregory % Which division performed the best? BristolDardenGregory (b) Calculate residual income. (If the amount is negative then enter with a negative sign preceding the number e.g. -5,125 or parenthesis. e.g. (5,125).) Residual Income Bristol $ Darden $ Gregory $ Which division performed the best? BristolDardenGregory (c) Assume that Ashton’s weighted-average cost of capital is 6% and its tax rate is 25%. Calculate economic value added. (If the amount is negative then enter with a negative sign preceding the number e.g. -5,125 or parenthesis. e.g. (5,125).) Economic Value Added Bristol $ Darden $ Gregory $ Which division performed the best? BristolGregoryDarden

Explanation / Answer

Minimum return on investment=10%

Book value of assets

Bristol            800,000

Darden           449,000

Gregory          752,300

Operating income

Bristol              91,620

Darden           94,960

Gregory          58,590

Return on investment

Bristol=Net operating income/Book value of assets * 100=   91,620/800,000*100 =11.45 %

Darden= Net operating income/Book value of assets * 100 = 94,960/449000*100 =21.14 %

Gregory= Net operating income/Book value of assets * 100 = 58,590/752,300 *100=7.78 %

Darden is best performing .

Residual Income

Bristol=Net operating income-(Book value of assets * Required rate) = 91,620-(800,000*.10) = $11,620

Darden=Net operating income-(Book value of assets * Required rate) =94,960-(449,000*.10) = $50,060

Gregory=Net operating income-(Book value of assets*Required rate)=58,590-(752,300*.10)=$-16,640

Darden has maximum residual income

Economic value added= (Net investment) x (Actual return on investment – Percentage cost of capital)

Bristol=800,000 * (.1145-.10) = $11,600

Darden=449,000 * (.2114-.10)=$50018.6

Gregory=752300 * (.0778-.10)=$-16,701.16

Darden has maximum EVA.

Best performance is secured by Dardenn.

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