Question

ROI and EVA

The Bella Vista Woodwork Company uses return on investment and economic value added as performance evaluation measures for its division managers. The company's weighted average cost of capital is 10 percent. Assume a tax rate of 20 percent. Financial data for the company's three divisions follow. (all currencies converted to US $)

US Division Asia Division Europe Division

Sales $300,000 $375,000 $450,000

Operating Income 25,000 28,000 29,500

Average operating Assets 150,000 125,000 175,000

Average Current liabilities 10,000 5,000 15,000

Weighted average cost of capital 10% 10% 10%

a. Compute the return on investment for each division

b. Compute the economic value added amount for each division

c. Which division's manager is performing the best using ROI? (show work)

d. Which division manager is performing the best using economic value added? (show work)

Answer 1

a.ROI = Operating Income/Average Operating Assets

for US division, ROI = 25,000/150,000 = 16.67%

for Asia division, ROI = 28,000/125,000 = 22.4%

for Europe division, ROI = 29,500/175,000 = 16.86%

b.EVA = Net Operating Income after Tax – Net assets*WACC

for US division, EVA = 25,000(1-0.2) – 140,000*10%

= $6,000

For Asia division, EVA = 28,000(1-0.2) – 120,000*10%

= $10,400

For Europe division, EVA = 29,500(1-0.2) – 160,000*10%

= $7,600

*Net Assets = Operating Assets – Average Current Liabilities

c.Asia division's manager is performing the best using ROI, since highest ROI

d. Asia division’s manager is performing the best using economic value added, since highest EVA