Swifty Corporation operates three divisions—Archer, Barrett, and Corvell. Divisi

Question

Swifty 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. Swifty’s senior management team has recently discovered that the Corvell Division manager has chosen not to invest in projects that would have been beneficial 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.

(a)

Calculate the return on investment, residual income, and EVA for each division. (Round ROI answers to 0 decimal places, e.g. 15% and all other answers to 0 decimal places, e.g. 5,215. If the amount is negative then enter with a negative sign preceding the number, e.g. -5,125 or parentheses, e.g. (5,125).)

Archer Barrett Corvell Assets $29,922,000 $19,971,000 $7,992,900 Current liabilities 2,251,200 757,600 328,600 Operating income 4,488,300 3,195,360 1,518,651 Minimum rate of return 12% 12% 12% Weighted average cost of capital 8% 8% 8% Tax rate 30% 30% 30%

Explanation / Answer

Answer a.

Archer Division:

Investment = Assets - Current Liabilities
Investment = $29,922,000 - $2,251,200
Investment = $27,670,800

ROI = Operating Income / Investment
ROI = $4,488,300 / $27,670,800
ROI = 16.22%

Residual Income = Operating Income - Minimum Rate of Return * Investment
Residual Income = $4,488,300 - 12% * $27,670,800
Residual Income = $1,167,804

EVA = Operating Income * (1 – tax) - WACC * Investment
EVA = $4,488,300 * (1 - 0.30) - 8% * $27,670,800
EVA = $928,146

Barrett Division:

Investment = Assets - Current Liabilities
Investment = $19,971,000 - $757,600
Investment = $19,213,400

ROI = Operating Income / Investment
ROI = $3,195,360 / $19,213,400
ROI = 16.63%

Residual Income = Operating Income - Minimum Rate of Return * Investment
Residual Income = $3,195,360 - 12% * $19,971,000
Residual Income = $798,840

EVA = Operating Income * (1 – tax) - WACC * Investment
EVA = $3,195,360 * (1 - 0.30) - 8% * $19,213,400
EVA = $699,680

Corvell Division:

Investment = Assets - Current Liabilities
Investment = $7,992,900 - $328,600
Investment = $7,664,300

ROI = Operating Income / Investment
ROI = $1,518,651 / $7,664,300
ROI = 19.81%

Residual Income = Operating Income - Minimum Rate of Return * Investment
Residual Income = $1,518,651 - 12% * $7,664,300
Residual Income = $598,935

EVA = Operating Income * (1 – tax) - WACC * Investment
EVA = $1,518,651 * (1 - 0.30) - 8% * $7,664,300
EVA = $449,912

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