Sapsora Company uses ROI to measure the performance of its operating divisions a

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 12 percent. Division A Division B Total assets $ 6,000,000 $ 8,750,000 Current liabilities $ 500,000 $ 1,750,000 After-tax operating income $ 1,000,000 $ 1,180,000 ROI 25 % 14 %

a. Which division is more profitable in absolute dollars? Division A

b. Compute the EVA for Division A and Division B. A= 340,000 and B= 340,00

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 $37,500. Would the manager be motivated to invest in the new project? Yes

I only received partial credit for this question so I answered something worng can you please walk through a-c with the correct answers?

Explanation / Answer

SOLUTION

(A) Division A is more profitable as the return on investment is higher in case of Division A. However, in terms of quantitative profit Division B is more profitable.

(B)

EVA = After tax income - {(Total assets - current liabilities)* WAC}

EVA of Division A = $1,000,000 - (5,500,000 * 12%)

= $1,000,000 - $660,000

= $340,000

EVA of Division B = $1,180,000 - (7,000,000 * 12%)

= $1,180,000 - $840,000

= $340,000

(C) The manager should choose to go for the project only if the EVA of the division increases. Revised Assets and Operating Income is as under-

EVA = $1,037,500 - ($5,750,000 * 12%)

=  $1,037,500 - $690,000

= $347,500

Since the EVA of the division increase they should select the project.

Division A ($) Division B ($) Total Assets (A) 6,000,000 8,750,000 Current Liability (B) 500,000 1,750,000 Capital Employed (A-B) 5,500,000 7,000,000 After Tax Operating Income 1,000,000 1,180,000

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