Evaluating segment performance Hannalinn Corporation operates three divisions—Ar

Question

Evaluating segment performance

Hannalinn Corporation operates
three divisions—Archer, Barrett, and Corvell. Division managers are evaluated based
on the division’s return on investment, and historically, the Corvell division has consistently
outperformed the other two divisions. Hannalinn’s senior management team has recently
discovered that the Corvell Division manager has chosen not to invest in projects that would
have been benefi cial to the organization as a whole, and they are concerned that the current
practice of evaluating the division managers’ performance using return on investment may
have contributed to these decisions. Therefore, the senior management team is considering the use of residual income or EVA to evaluate the division managers’ performance. The following
data is taken from the most recent year of operations.

Required
a. Calculate the return on investment, residual income, and EVA for each division.
b. Comment on the expected results of switching performance evaluation methods to
either residual income or EVA.

Archer Barrett Corvell Assets $30,000,000 $20,000,000 $8,000,000 Current liabilities 2,250,000 750,000 325,000 Operating income 4,200,000 3,200,000 1,520,000 Minimum rate of return 14% 14% 14% Weighted average cost of capital 8% 8% 8% Tax rate 30% 30% 30%

Explanation / Answer

If a switch-over is made from evaluating a division on the basis of ROI to Residual income method, then Barrett's performance is to be appreciated.

If a switch-over is made to EVA concept, then Archer's performance is to be appreciated.

Particulars Archer Barrett corvell Assets A 30,000,000 20,000,000 8,000,000 current liabilities B 2,250,000 750,000 325,000 Net investment C 27,750,000 19,250,000 7,675,000 1. Return on investment Operating income D 4,200,000 3,200,000 1,520,000 Return on investment % 15.14 16.62 19.80 2. Residual income Net operating income A 4,200,000 3,200,000 1,520,000 Minimum required return B 14% 14% 14% average operating assets 27,750,000 19,250,000 7,675,000 RI=A-(B*C) 315,000 505,000 445,500

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