Question

Question 6 • Time: 20 minutes • Total: 12 marks Mary's Auto Shop Inc. allows its divisions to operate as autonomous units. Their results for the current year were as follows: Revenues Current assets Capital assets Current liabilities Net operating income After-tax income Weighted average cost of capital Sport Terrain $2,200,000 $995,000 290,000 90,000 870,000 660,000 100,000 100,000 230,000 40,000 184,000 32,000 City $6,600,000 620,000 1,590,000 500,000 600,000 480,000 10% 10% 10% Required: For each division compute (to two decimal) the: 1. Return on sales in % 2. Return on investment (to two decimal) based on total assets employed in % 3. Economic value added 4. Residual income based on net operating income

Answer 1

Requirement 1:

	Sport	Terrain	City
Revenue	$       2,200,000	$ 995,000	$       6,600,000
Net Operating Income	$ 230,000	$          40,000	$ 600,000
Return on Sales	10.45%	4.02%	9.09%

Return on sales = (Net Operating Income / Revenue) * 100

Requirement 2:

	Sport	Terrain	City
Current Assets	$ 290,000	$ 90,000	$ 620,000
Capital Assets	$ 870,000	$ 660,000	$       1,590,000
Total Assets	$       1,160,000	$ 750,000	$       2,210,000
Current Liabilities	$ 100,000	$ 100,000	$ 500,000
Capital Employed	$       1,060,000	$ 650,000	$       1,710,000
Net Operating Income	$ 230,000	$ 40,000	$ 600,000
Capital Employed	$       1,060,000	$ 650,000	$       1,710,000
Return on Investment	21.70%	6.15%	35.09%

Return on Investment = (Net Operating Income / Capital Employed) * 100

Requirement 3:

	Sport	Terrain	City
Current Assets	$         290,000	$ 90,000	$ 620,000
Capital Assets	$         870,000	$      660,000	$       1,590,000
Total Assets	$ 1,160,000	$      750,000	$       2,210,000
Current Liabilities	$         100,000	$      100,000	$ 500,000
Invested Capital	$ 1,060,000	$      650,000	$       1,710,000
Weighted Average Cost of capital	10%	10%	10%
Cost of Capital	$         106,000	$ 65,000	$ 171,000
Net Operating Income after Tax	$         184,000	$ 32,000	$ 480,000
Cost of Capital	$         106,000	$ 65,000	$ 171,000
Economic Value Added	$ 78,000	$ -33,000	$ 309,000

Economic Value Added = NOPAT - Cost of capital

Requirement 4:

	Sport	Terrain	City
Net Operating Income	$         230,000	$          40,000	$         600,000
Cost of Capital	$         106,000	$          65,000	$         171,000
Residual Income	$         124,000	$        -25,000	$         429,000

Residual Income = Net operating Income - Cost of Capital