Exercise 12-11 Exercise 12-11 Consider the following data, which relate to the t

Question

Exercise 12-11

Exercise 12-11

Consider the following data, which relate to the two divisions of McIntyre Products:
Division 1 Division 2 Total assets $68,000,000 $23,000,000 Noninterest-bearing current liabilities 4,410,000 2,220,000 NOPAT 11,400,000 5,920,000 Required rate of return 11% 10%
Compare the two divisions in terms of return on investment and residual income. In the past year, which division has created the most wealth for McIntyre shareholders? (Round ROI to 2 decimal place, e.g. 15.25%.)
Division 1 Division 2 ROI % % Residual income/EVA

which had highest return on investment Division 2 or Division 1

and which one Division 1 or Division 2 had highest residual income.

However, which one Division2 or Division 1 has created most wealth for McIntyre shareholders.

Explanation / Answer

Division 1 -Return on investment = NOPAT / Total Investment = 11,400,000/ 68,000,000 = .167

Division 2-Return on investment = NOPAT / Total Investment = 5920000/23000000 = .257

Division 2 is having higher ROI

EVA

Option 1-

EVA = NOPAT - (cost of capital*capital)

Capital = 68000000 - 4410000 = 63590000

EVA = 11400000 -(63590000*11%) = 4405100 OPTION 1 EVA

Option 2 EVA=

Capital = 23000000 - 2220000 = 20780000

EVA = 5920000 - ( 20780000*10%) = 3842000

Option 1 has generated more wealth

Option is having higher EVA so it should be applied.

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