(b computation is not clear to me). Sapsora Company uses ROI to measure the perf
ID: 2446957 • Letter: #
Question
(b computation is not clear to me).
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 below. 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? b. Would EVA more clearly show the relative contribution of the two divisions to the company as a whole? Show the computations. 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 choose to invest in the new project?Explanation / Answer
Solution :
a. Division A is more Profitable as it has higher ROI
b. Computation of EVA
A
B
ASSET
6,000,000
8,750,000
LIABILITY
500,000
1,750,000
CAPITAL (ASSET - LIABILITY)
5,500,000
7,000,000
EVA = Net operating Profit after Tax - (nvestment x cost of capital)
340,000
340,000
C. Decision regarding new project
INVESTMENT
5,500,000
ROI
25%
PROFIT
1,375,000
Profit after accepting new project
1,412,500
INVESTMENT AFTER NEW PROJECT
5,750,000
NEW ROI
24.57
Manager would not choose new project as ROI is decreasing on acceptance
EVA = Economic value added.
a. Division A is more Profitable as it has higher ROI
b. Computation of EVA
A
B
ASSET
6,000,000
8,750,000
LIABILITY
500,000
1,750,000
CAPITAL (ASSET - LIABILITY)
5,500,000
7,000,000
EVA = Net operating Profit after Tax - (nvestment x cost of capital)
340,000
340,000
C. Decision regarding new project
INVESTMENT
5,500,000
ROI
25%
PROFIT
1,375,000
Profit after accepting new project
1,412,500
INVESTMENT AFTER NEW PROJECT
5,750,000
NEW ROI
24.57
Manager would not choose new project as ROI is decreasing on acceptance