Home Page Layout Formulas Data Insert New Car Performance Parts Division Division 2 Total assets 3 Current liabilities 4 Operating income 5 Required rate of return $33,000,000 $ 6,600,000 $ 2,475,000 $28,500,000 $ 8,400,000 $ 2,565,000 12% 12% 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. Required 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: Iong-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.
Home Page Layout Formulas Data Insert New Car Performance Parts Division Division 2 Total assets 3 Current liabilities 4 Operating income 5 Required rate of return $33,000,000 $ 6,600,000 $ 2,475,000 $28,500,000 $ 8,400,000 $ 2,565,000 12% 12% 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. Required 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: Iong-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.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Question
ROI, 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 nancial measures for 2017 are as follows:
Transcribed Image Text:Home
Page Layout
Formulas
Data
Insert
New Car
Performance
Parts Division
Division
2 Total assets
3 Current liabilities
4 Operating income
5 Required rate of return
$33,000,000
$ 6,600,000
$ 2,475,000
$28,500,000
$ 8,400,000
$ 2,565,000
12%
12%
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.
Required
Transcribed Image Text: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: Iong-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.
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