Sapsora Company uses ROI to measure the performance of its operating divisions a

Question

Sapsora Company uses ROI to measure the performance of its operating divisions and to reward division managers. A summary of the annual reports from two divisions is shown below. The company's weighted-average cost of capital is 12 percent. Which division is more profitable in absolute dollars Division A Division B Would EVA more clearly show the relative contribution of the two divisions to the company as a whole Suppose the manager of Division A was offered a one-year project that would increase his investment base by $350,000 and show a profit of $35,000. Would the manager be motivated to invest in the new project No Yes

Explanation / Answer

(a)

Division B is more profitable in absolute dollars.

(b)

Formulae of EVA = (Net investment) x (Actual return on investment – Percentage cost of capital)

Net Investment for Division A = (6360000 – 800000) = $5560000

Net Investment for Division A = (8390000 – 1950000) = $6440000

EVA for Division A = $5560000 x (20 – 12) = $444800

EVA for Division B = $6440000 x (15 – 12) = $193200

(C)

Answer will be (No) because manager of division will get (35000 x 100 / 350000) = 10% return that is less than cost of capital (12%).

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