Question

Problem #1

            

            Below is information for Division Z:

	Division Z
Sales	1,250,000
Operating income	$75,000
Operating assets	?
ROI	15%
Operating income Margin	?
Operating assets Turnover	?
Minimum rate of return	10%

Required:

1)         What is the residual income for Division Z?

           

2)         What is the turnover for Division Z?

	4.

Problem #2

The MistleToe Corporation sells Christmas decorations.  They had the following financial information for 2019:

Pre-Tax Operating Profit		$6,000,000
Total Capital employed		$12,000,000
Amount of Debt		$8,000,000
MV of Equity		$4,000,000
Pre-tax cost of debt		12%
Securities premium over risk-free rate		9%
Risk-Free rate		6%
Tax rate		35%

The MistleToe Corporation has decided to implement an EVA bonus plan for its top executives.  

Required: Calculate the Economic Value Added (EVA) to the corporation in 2019.

Answer 1

Answer of Problem 1-Part 1:

Operating Income Margin = Operating Income / Sales *100
Operating Income Margin = $75,000 / $1,250,000 * 100
Operating Income Margin = 6%

ROI = Operating Income Margin * Turnover
0.15 = 0.06 * Turnover
Turnover = 0.15 / 0.06
Turnover = 2.5

Turnover = Sales / Operating Assets
2.5 = $1,250,000 / Operating Assets
Operating Assets = $1,250,000 / 2.5
Operating Assets = $500,000

Residual Income = Operating Income – (Minimum Rate of Return * Operating Assets)
Residual Income = $75,000 – (10% * $500,000)
Residual Income = $75,000 - $50,000
Residual Income = $25,000

Answer of Problem1-Part 2:

ROI = Operating Income Margin * Turnover
0.15 = 0.06 * Turnover
Turnover = 0.15 / 0.06
Turnover = 2.5