Question

Washington Company has two divisions: the Adams Division and the Jefferson Division. The following information pertains to last year's results:

Adams Division Jefferson Division

Net (after-tax) income $611,050 $359,100

Total capital employed 4,720,000 3,672,500

Washington's actual cost of capital was 11%.

Required:

1. Calculate the EVA for the Adams Division. If required, enter a negative EVA as a negative number by entering your answer with the minus sign.
$

2. Calculate the EVA for the Jefferson Division. If required, enter a negative EVA as a negative number by entering your answer with the minus sign.
$

3. Conceptual Connection: Is each division creating or destroying wealth?

Adams Division - creating or destroying

Jefferson Division - creating or destroying

4. Describe generally the types of actions that Washington’s management team could take to increase Jefferson Division’s EVA?

a. Increase the after-tax operating profit that is generated from using the same amount of invested capital.

b. Continue to generate the same after-tax operating profit but use less capital to do so.

c. Continue to generate the same after-tax operating profit using the same amount of capital, but with a lower cost of capital.

d. Decrease the after-tax operating profit that is generated from using the same amount of invested capital.

e. Continue to generate the same after-tax operating profit but use more capital to do so.

Net (after-tax) income $617,100 $371,700 Total capital employed 4,320,000 3,380,000 In addition, Washington Company's top management has set a minimum acceptable rate of return equal to 11%. Required: Enter negative values as negative numbers. 1. Calculate the residual income for the Adams Division s 2. Calculate the residual income for the Jefferson Division

Answer 1

1.) EVA = Operating profit after tax - (invested capital x cost of capital)

= 611,050 - (4,720,000 x 11%) = $91,850

2.) EVA = 359,100 - (3,672,500 x 11%) = -$44,875

3.) Adams division : Creating

Jefferson division : Destroying

4.) Optiom C i.e. Continue to generate the same after-tax operating profit using the same amount of capital, but with a lower cost of capital.

5.) Residual income :-

Adams : 617,100 - (4,320,000 x 11%) = $141,900

Jefferson : 371,700 - (3,380,000 x 11%) = -$100