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Calculate the return on investment

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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:

 

Car Division

Parts Division

Total assets

$3,300,000

$2,850,000

Current liabilities

$660,000

$840,000

Operating profit

$247,500

$256,500

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?

Reference no: EM133053196

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