Back Mountain Industries (BMI) has two divisions: East and West. BMI has a cost

Question

Back Mountain Industries (BMI) has two divisions: East and West. BMI has a cost of capital of 25 percent. Selected financial information (in thousands of dollars) for the first year of business follows:

aR&D is assumed to benefit two periods. All R&D is spent at the beginning of the year.

Required:

a-1. Evaluate the performance of the two divisions assuming BMI uses economic value added. (Enter answers in thousands of dollars. Round your answers to 1 decimal place.)

East West Sales revenue $ 4,400 $ 8,400 Income 795 900 Investment (beginning of year) 1,850 3,400 Current liabilities (beginning of year) 370 370 R&D expendituresa 1,350 1,250

Explanation / Answer

Economic value added for East = NOPAT-Operating capital×After tax cost of debt

= $795-$1,850×25%

= $332.5

Economic value added for West = NOPAT-Operating capital×After tax cost of debt

= $900-$3,400×25%

= $50

Though investment is east was lower, economic value added by the east was very higher than the double sized west. Investment in East should be increased if possible.

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