Question 1 Wildhorse Corporation recently announced a bonus plan to reward the m

Question

Question 1 Wildhorse Corporation recently announced a bonus plan to reward the manager of its most profitable division. The three divisional managers are to decide which performance measure will be used to evaluate profitability. Wildhorse Corporation requires a 10% minimum return on investment. The following information is available for the year just ended. Gross Book Value Divisional Operating Division of Assets Income Ashton Drye Poole $800,000 $94,740 746,500 91,210 449,000 57,850 (a) Calculate return on investment. (Round ROI to 2 decimal places, e.g. 5.12%.) Return on Investment Ashton Drye Poole Which division performed the best?

Explanation / Answer

Solution (a) Calculation of return on investment

Return on Investment =

Divisional Operating Income/Gross book value of assets * 100

11.84%

($94740/$800000)

12.22%

($91210/$746500)

12.88%

($57850/$449000)

Solution (b) Calculation of Residual Income

Residual Income = Net operating Income - Required Return

Residual Income

(A - B)

$80000

($800000*10%)

$74650

($746500*10%)

$44900

($449000*10%)

Solution (c) - Calculation of Economic value added (EVA)

EVA = Net operating profit after tax - Required return on Weighted average cost of capital

Economic value added

(A-B)

$75792

($94740 - $94740*20%)

$64000

($800000 * 8%)

$72968

($91210 - $91210*20%)

$59720

($746500 * 8%)

$46280

($57850 - $57850*20%)

$35920

($449000 * 8%)

Manager Return on investment Rank Ashton

11.84%

($94740/$800000)

3 Drye

12.22%

($91210/$746500)

2 Poole

12.88%

($57850/$449000)

1 (Performed best)

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