Colonial Pharmaceuticals is a small firm specializing in new products. It is org
ID: 2521370 • Letter: C
Question
Colonial Pharmaceuticals is a small firm specializing in new products. It is organized into two divisions, which are based on the products they produce. AC Division is smaller and the life of the products it produces tend to be shorter than those produced by the larger SO Division. Selected financial data for the past year is shown below. Divisional investment is as of the beginning of the year. Colonial Pharmaceuticals uses a 8 percent cost of capital and uses beginning-of-the-year investment when computing ROI and residual income. Ignore income taxes Allocated corp. overhead Cost of goods sold Divisional investment R&D; Sales SG&A; AC Division $ 650 4,000 9,800 2,540 9,600 820 SO Division $ 900 8,800 71,000 5,400 21,800 630 R&D; is assumed to have a two-year life in the AC Division and a nine-year life in the SO division. All R&D; expenditures are spent at the beginning of the year. Assume there are no current liabilities and (unrealistically) that no R&D; investments had taken place before this year Al, the manager of the AC Division, complains that the calculation of EVA is unfair, because a much longer life is assumed for the SO Division in calculating EVA. Sean, the manager of SO, responds that EVA is supposed to reflect economic reality and that the reality is that R&D; investments in SO Division do have a longer life Required: a. Assume that the economic life of R&D; investments is two years in the AC Division. What economic life would the R&D; investments in the SO Division have to make EVA in the two divisions equal? (Round EVA to 2 decimal places and final answer to 1 decimal places.)Explanation / Answer
Performance Evaluation
AC Divn SO Divn Sales 8000 20000 Cost of goods sold 3200 7000 Gross Profit 4800 13000 Allocated corp. overhead 600 1800 SG&A 700 1530 R&D 2000 3600 Net Income 1500 6070 Divisional investment(DI) 9000 80000 ROI @ 9% COC 810 7200 Net Income as above 1500 6070 Excess(Shortfall) 690 -1130 Actual % Net Income/DI 1500/9000 6070/80000 (As against the reqd. 9%) 16.67 7.59