Question

Becky’s Bikes Inc. has two divisions: Retail and Service. The following information is for each division at Becky’s Bikes for the most recent fiscal year.

	Retail Division	Service Division
Income Statement
Sales	$1,200,000	$1,000,000
Cost of sales	550,000	400,000
Gross margin	650,000	600,000
Allocated overhead (from corporate)	210,000	180,000
Marketing expense	130,000	120,000
Administrative expense	60,000	55,000
Operating income	250,000	245,000
Income tax expense (40% rate)	100,000	98,000
Net income	150,000	147,000
Balance Sheet Information
Average operating assets	$600,000	$375,000
Non-interest bearing current liabilities	100,000	75,000
Percent cost of capital	12%	12%

To calculate EVA, management requires adjustments for marketing and non-interest bearing current liabilities as outlined below.

Marketing will be capitalized and amortized over several years resulting in an increase to average operating assets of $45,000 for the Retail division and $37,500 for the Services division. On the income statement, marketing expense for the year will be added back to operating income, then marketing amortization expense for one year will be deducted. The current year amortization expense will total $30,000 for the Retail division and $20,000 for the Services division.

Non-interest bearing liabilities will be deducted from average operating assets.

Required
Calculate economic value added (EVA) for each division and comment on your results.

Answer 1

Economic value added	= Net operating profit after taxes - Invested capital * Weighted average cost of capital
	Retail Division	Service division
Net operating profit after taxes	1,50,000+1,30,000*0.60-30,000*0.6	1,47,000+1,20,000*0.60-20,000*0.60
	= 2,10,000	= 2,07,000
Invested capital	6,00,000+45,000-1,00,000	3,75,000+37,500-75,000
	= 5,45,000	= 3,37,500
Econimc value added	2,10,000 - 5,45,000*12%	2,07,000 - 3,37,500*12%
	= 1,44,600	= 1,66,500