Question

Sapsora Company uses ROI 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 11 percent.

	Division A				Division B
Total assets	$	6,100,000			$	8,650,000
Current liabilities	$	550,000			$	1,800,000
After-tax operating income	$	1,020,000			$	1,163,000
ROI		24	%			14	%

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 $250,000 and show a profit of $32,500. Would the manager be motivated to invest in the new project?

Answer 1

Sapsora Company Requirement a Division A is more profitable with 24% ROI. Requirement b EVA = After-Tax Operating Income –{Division's Total Assets - Division's Current Liabilities } x Weighted Average Cost of Capital Division A Division B Total Assets 6100000 8650000 Current Liability -550000 -1800000 Capital Employed 5550000 6850000 Weight-Average Cost of Capital 11% 11% After Tax Operating Income 1020000 1163000 ROI 24% 14% EVA 409500 409500 Division A EVA = 1020000 - (5550000 X 11%) = 409500 Division B EVA = 1163000 - ( 6850000 X 11%) = 409500 Requirement c Total assets Current liability Capital employed WACC After tax operating income EVA Division A 6350000 -550000 5800000 11% 1052500 Division A EVA = 1052500 - ( 5800000 X 11%) = 414500