Reference no: EM133053196
Question - Benson Ltd operates a Car Division (that sells high-performance sport cars) and a Parts Division (that sells performance-improvement parts for family cars). The company's required rate of return is 8%. Some divisional financial measures for the current quarter are as follows:
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Car Division
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Parts Division
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Total assets
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$3,300,000
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$2,850,000
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Current liabilities
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$660,000
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$840,000
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Operating profit
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$247,500
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$256,500
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Required -
(a) Calculate the return on investment (ROI) for each division using total assets as a measure of invested capital.
(b) Calculate the residual income (RI) for each division using total assets minus current liabilities as a measure of invested capital.
(c) The Car Division manager argues that the Parts Division has 'loaded up a lot of short-term debt' to boost its RI. Calculate an alternative RI for each division that is not sensitive to the amount of short-term debt taken on by the divisions. Comment on the result.
(d) Benson Ltd has two sources of funds: long-term debt with a market value of $1,800,000 at an after-tax interest rate of 6%, and equity capital with a market value of $1,200,000 and a cost of equity of 12%. The company tax rate is 30%. Calculate the economic valued added (EVA) for each division.
(e) Are the measures above consistent in comparing the performance of the two divisions?