Performance Auto Company operates a New Car Division(that sells high performance sports cars) and a Performance parts division(that sells performance improvement parts for family cars). Some division financial measures for 2008 are as follows:
|
|
New Car Division |
Performance Parts Division |
| Total Assets |
$33,000,000 |
$28,500,000 |
| Current liabilities |
$6,600,000 |
$8,400,000 |
| Operating income |
$2,475,000 |
$2,565,000 |
| Required rate of return |
12% |
12% |
1. Calculate return on investment(ROI) for each division using operating income as a measure of income and total assets as a measure of investment.
2. Calculate residual income(RI) for each division using operating income as a measure of income and total assets minus current liabilities as ameasure of investment.
3. William Abraham, the New car division manager, argues that the performance parts division has "loaded up on 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 Performance parts division. Comment on the result.
4. Performance auto Company, whoe tax rate is 40% has two sources of funds:long term debt with a market value of $18,000,000 at an interest rate of 10% and equity capital with a market value of $12,000,000 and a cost equity of 15%. Applying the same weighted average cost of capital (WACC) to each division, calculate EVA fpor each division.
5. Use the preceding calculations to comment on the relative performance of each division.