Question

Accelerate 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 financial measures for 2017 are as follows: (Click the icon to view the data.)

Answer 1

Summary of information
Particulars	New Car Division	Performance Part Division
A	Total Assets	$            35,000,000	$            32,312,500
B	Current Liabilities	$              6,500,000	$              8,700,000
C	Operating Income	$              2,450,000	$              2,585,000
D	Required rate of Return	9.00%	9.00%
Answers:
Particulars	New Car Division	Performance Part Division
1	Rate of return (ROI)	7.00%	8.00%
	(C÷A)
Particulars	New Car Division	Performance Part Division
2	Residual Income (RI)	8.60%	10.95%
	{C÷(A-B)}

3 Alternative Residual Income (RI) without taking into consideration short term debts
Particulars	New Car Division	Performance Part Division
	Alternative Residual Income/(loss) (RI)	$                (700,000)	$                (323,125)
	{Operating income - (minimum required return x operating assets}

Performance of New car Division is not good as compared to Performance parts division because alternative residual income of new car division is 2% i.e. ($700000÷$3500000) less then its minimum required return. Whereas, alternative residual income of Performance parts division is 1% i.e. ($323125÷$32312500)less then its minimum required return. Hence claim of New car Division is not valid.

4. Economic Value Added = NOPAT - Total cost of fund

Particulars	New Car Division	Performance Part Division
(A)	NOPAT (Assuming Operating income is pre tax)	$              1,470,000	$              1,551,000
	{Operating Income*(1-Tax rate)}
(B=C+D)	Total Cost of fund
	(Cost of Debt + Cot of Equity)
(C)	Cost of Debt	$              1,140,000	$              1,140,000
	{Value of long term debt*Interest Rate*(1-tax Rate)}
(D)	Cost of Equity	$              2,240,000	$              2,240,000
	(Total fund from equity*Cost of equity%)
(A-B)	Economic Value Added (EVA)	$            (1,910,000)	$            (1,829,000)

5. Performance of Performance parts division is good as compared to new car division. However, while evaluating performance of different divisions of the entity, entity need to measure performance based on different market forces e.g. availability of demand of the product, competition in the market, ease of access to capital, availability of resources etc.