Question

Universal Electronics, Inc. (UEI), which started operations one year ago, has two divisions: Consumer and Commercial. Both divisions invest heavily in R&D, which is assumed to benefit five years. R&D spending is made uniformly throughout the year. UEl has a cost of capital of 11 percent. Selected financial information for the two divisions (in thousands of dollars) for the year just completed follows. Sales revenue Divisional income Divisional investment Current liabilities R&D Consumer 54,000 11,500 35,500 4,200 4,200 Commercial 85,000 11,925 39,750 4,000 4,200 Required: Evaluate the performance of the two divisions assuming UEl uses economic value added (EVA). (Enter you answers in dollars rounded to 1 decimal place.) EVA of Consumer division EVA of Commercial division Which division performed better?

Answer 1

Investment in $\mathrm{R} \& \mathrm{D}$ is assumed to benefit five years. However, all has been expensed Therefore, first calculate adjusted income and adjusted investment for each division.

Calculate adjusted income for each division as follows:

Adjusted profit for Consumer Division $=\$ 11,500+(\$ 4,200 \times 4 / 5)=\$ 14,860$

Adjusted profit for Commercial Division $=\$ 11,925+(\$ 4,200 \times 4 / 5)=\$ 15,285$

Calculate adjusted investment for each division as follows:

Adjusted investment for Consumer Division $=\$ 35,500-\$ 4,200+(\$ 4,200 \times 4 / 5)=\$ 34,660$

Adjusted investment for Commercial Division $=\$ 39,750-\$ 4,000+(\$ 4,200 \times 4 / 5)=\$ 39,110$

Now, calculate EVA for each division as follows:

EVA for Consumer Division $=\$ 14,860-(\$ 34,660 \times 11 \%)=\$ 11,047.40$

EVA for Commercial Division $=\$ 15,285-(\$ 39,110 \times 11 \%)=\$ 10,982.90$

Therefore, Consumer Division's performance is better and it is adding more value to the shareholders than the Commercial Division.