Question

Heather Smith Cosmetics (HSC) manufactures a variety of products and is organized into three divisions (investment centers): soap products, skin lotions, and hair products. Information about the most recent year’s operations follows. The information includes the value of intangible assets, including research and development, patents, and other innovations that are not included on HSC’s balance sheet. Were these intangibles to be included in the financial statements (as they are for EVA®), the increase in the balance sheet and the increase in after-tax operating income would be as given below: Division Operating Income Average Total Assets Value of Intangibles Intangibles’ Effect on Income Soap products $ 3,250,000 $ 60,000,000 $ 1,500,000 $ 1,000,000 Skin lotions 2,750,000 33,000,000 8,000,000 6,000,000 Hair products 5,000,000 55,000,000 1,000,000 700,000 Minimum desired rate of return 5.00 % Cost of capital 4.00 % Required: 1. Calculate the return on investment (ROI) for each division. (Round your answers to 2 decimal places. (i.e. .1234 = 12.34%)) 2. Calculate the residual income (RI) for each division. 3. Calculate EVA® for each division.

Answer 1

Answers:

	Net operating income	Average operating assets
Soap products	$3250000	$60000000
Skin lotion	$2750000	$33000000
Hair products	$5000000	$55000000
Min desire rate of return	5%
Cost of capital	4%

1.ROI = Net operating income / average operating expenses ×100

Soap products(3250000/60000000×100)	5.42%
Skin lotion(2750000/33000000×100)	8.33%
Hair products(5000000/55000000×100)	9.09%

2.RI = operating income -(average operating assets ×desired rate of return)

Soap products(3250000-(60000000×5%))	$250000
Skin lotion(2750000-(33000000×5%))	$1100000
Hair products(5000000-(55000000×5%))	$2250000

3.EVA = operating income -(average operating assets×cost of capital)

Soap products(3250000-(60000000×4%))	$850000
Skin lotion(2750000-(33000000×4%))	$1430000
Hair products(5000000-(55000000×4%))	$2800000