Question

Sapsora Company uses ROI to measure the performance of its operating divisions and to reward division managers. A summary of the annual reports from two divisions is shown as follows. The company’s weighted-average cost of capital is 12 percent.

	Division A				Division B
Total assets	$	6,000,000			$	8,750,000
Current liabilities	$	500,000			$	1,750,000
After-tax operating income	$	1,000,000			$	1,180,000
ROI		25	%			14	%

a. Which division is more profitable in absolute dollars?

b. Compute the EVA for Division A and Division B.

c. Suppose the manager of Division A was offered a one-year project that would increase his investment base by $250,000 and show a profit of $37,500. Would the manager be motivated to invest in the new project?

Answer 1

Answer 1

	Division A	Division B
Total Asset	6000000	8750000
Current Liabilities	500000	1750000
Investment	5500000	7000000
ROI (%)	25%	14%
Profit ($)	1375000	980000

Thus, Division A is more profitable.

Answer 2

EVA = After Tax Operating Income - (Total Asset - Total Liabilities)* Weighted Average Cost of Capital

	Division A	Division B
Total Asset	6000000	8750000
Current Liabilities	500000	1750000
Capital Employed	5500000	7000000
Weighted Average Cost of Capital	12%	12%
After Tax Operating Income	1000000	1180000
EVA	340000	340000

Answer 3

Revised Total Capital Employed [550000+250000]	5750000
After Tax Operating Income [1375000+37500]	1412500
Revised ROI (%)	24.57%

Since ROI is decreasing, manager will not accept the project.