Chapter 23, Problem 23.25E

ROI, RI, EVA. Hamilton Corp. is a reinsurance and financial services company. Hamilton strongly believes in evaluating the performance of its stand-alone divisions using financial metrics such as ROI and residual income. For the year ended December 31, 2017, Hamilton’s CFO received the following information about the performance of the property/casualty division:

Sales revenues	$ 900,000
Operating income	225,000
Total assets	1,500,000
Current liabilities	300,000
Debt (interest rate: 5%)	400,000
Common equity (book value)	500,000

For the purposes of divisional performance evaluation, Hamilton defines investment as total assets and income as operating income (that is, income before interest and taxes). The firm pays a flat rate of 25% in taxes on its income.

1. 1. What was the net income after taxes of the property/casualty division?

Required

1. 2. What was the division’s ROI for the year?
2. 3. Based on Hamilton’s required rate of return of 8%, what was the property/casualty division’s residual income for 2017?
3. 4. Hamilton’s CFO has heard about EVA and is curious about whether it might be a better measure to use for evaluating division managers. Hamilton’s four divisions have similar risk characteristics. Hamilton’s debt trades at book value while its equity has a market value approximately 150% that of its book value. The company’s cost of equity capital is 10%. Calculate each of the following components of EVA for the property/casualty division, as well as the final EVA figure:
   1. a. Net operating profit after taxes
   2. b. Weighted-average cost of capital
   3. c. Investment, as measured for EVA calculations