Sapsora Company uses ROl to measure the performance of its operating divisions a
ID: 2592572 • Letter: S
Question
Sapsora Company uses ROl to measure the performance of its operating divisions and to reward division managers. A summary of the annual reports from two divisions is shown as follows. The company's weighted-average cost of capital is 10 percent. Total assets Current liabilities After-tax operating income Division A $ 6,380,000 $ 800,000 $ 1,120,000 Division B $ 8,370,000 $ 1,950,000 1,204,000 ROI 24% 13% a. Which division is more profitable in absolute dollars? b. Compute the EVA for Division A and Division B c. 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 $38,500. Would the manager be motivated to invest in the new project?Explanation / Answer
Answer a
In absolute dollor term Division B is more profitable as After - tax operating income of Divison B is more than that of Division A.
Answer b
EVA = After - tax operating income - ( capital employed * weighted average cost of capital )
where , capital employed = Total Assets- Current Liabilities
EVA of Division A = $1,120.000 - [($6,380,000 - $800,000) * 10 %] = $562,000
EVA of Division B = $1,204.000 - [($8,370,000 - $1,950,000) * 10 %] = $562,000
Answer c
If the offered project increses the EVA of the Division than only manager of Division A should accept the said offer.
Revised Total Asset = $6,380,000 + $350,000 = $6,730,000
Revised After tax operating income = $1,120.000 + $38,500 = $1,158.500
Revised EVA of Division A = $1,158.500 - [($6,730,000 - $800,000) * 10 %] = $565,500
Dicision ; Since due to the new project the EVA of Division A increased by $3,500 ( $565,500 - $562,000) , the manager should invest in the new project.
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