1.Calculate return on investment (ROI) for each division using operating income
ID: 2525420 • Letter: 1
Question
1.Calculate return on investment (ROI) for each division using operating income as a measure of income and total assets as a measure of investment.
2. Calculate residual income (RI) for each division using operating income as a measure of income and total assets minus current liabilities as a measure of investment.
3.William Abraham, the new car division manager, argues that the performance parts division has “load- ed up on a lot of short-term debt” to boost its RI. Calculate an alternative RI for each division that is not sensitive to the amount of short-term debt taken on by the performance parts division. Comment on the result.
4.Performance Auto Company, whose tax rate is 40%, has two sources of funds: long-term debt with a market value of $18,000,000 at an interest rate of 10% and equity capital with a market value of $12,000,000 and a cost of equity of 15%. Applying the same weighted-average cost of capital (WACC) to each division, calculate EVA for each division.
5.Use your preceding calculations to comment on the relative performance of each division.
23-27 RO, RI, EVA. Performance Auto Company operates a new car division (that sells high- performance sports cars) and a performance parts division (that sells performance-improvement parts for family cars). Some division financial measures for 2017 are as follows: GB HomeInsert Page Layout Formulas Data 2 Total assets 3 Current liabilities 4. 5 Required rate of return New CarPerformance Division Parts Division $33,000,000 $28,500,000 S 6,600,000 8,400,000 $ 2,475,000$ 2,565,000 12% 12%Explanation / Answer
1) calculation of ROI for both projects
ROI=OPERATING INCOME/ ASSETS *100
FOR new car division =$2475000/33,00,0000*100
$0.075 or 7.5 percent
For performance car company
ROI =3565000/28500000*100
0.09or 9percent
2) calculation of RI, assets -current liabilities as measure of investment
RI= operating profit-(investment *required rate/100)
= $2475000-(33000000-6600000)*12'100
=$376200
For performance car division
RI= 2565000-(28500000-8400000)*12/100
$394200
3)Calculations of RI with out current liabilities
For new car division
RI= 2475000-(33000000*12/100)
=($1485000)
For performance car
RI=2565000-(28500000)*12/100
=(855000)
4)calculation of EVA
for new car division
EVA= NOPAT- invested cap*WACC)
=$1539000-($20100000*10.8/100)
($571500)
for performance car division
EVA =$1539000-($28500000-8400000)*10.8/100
=($631800)
5)
a) rerun on investment for projects for new car division is 7.6percent and performance car division is 9percent
RI for the projects are for new car 1485000 for performance car 693000 both projects got a negative RI if you calculate the RI with out a current liabilities the argument performance car division manager is not right
EVA IS. for both projects gegetive at WACC of 10.8
WACC is laclulated with the help of the following formula WACC =(( E/V*Re)+(D/V*Rd))*(1-t)
E- equity
D-day debt fund
T tax
V =E+D
THANK YOU
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