Major Corporation operates a wholesale electrical supply company with two locati

Question

Major Corporation operates a wholesale electrical supply company with two locations. Each location is evaluated as an investment center. Selected results from the latest year are as follows: Location #1 Location #2 Sales $600,000 $800,000 Variable expenses 460,000 660,000 Direct fixed expenses 100,000 80,000 Average Assets 890,000 780,000 Current liabilities 120,000 180,000 Required rate of return 10% 12% Weighted average cost of capital 8% 6% Tax rate 24% 28% Required: a. Calculate the residual income for Location #1. b. Calculate the EVA for Location #2.

Explanation / Answer

a. Residual income = Net operating income - Required rate of returnxAverage operating assets

   Net operating income = ($600000 - 460000 - 100000)(1-0.24)

= 30400

   Residual income = 30400 - (890000 - 120000)x10%

   = (46600)

b. EVA = Net operating income - Average operating assets x WACC

Net operating income = (800000 - 660000 - 80000)x(1-0.28)

   = 43200

   EVA = 43200 - (780000-180000)x6%

= 7200

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