Question

Consider the following facts: Divisin A in a firm has generated $847,000 of profits on $24 million worth of sales, using $32 million worth of dedicated assets. The cost for this firm is 9%, and the firm has invested %7.3 million in this division. A. Calculate the return on sales and return on Assets of Divisin A. If the hurdle rate for ROS and ROA in this firm are, respectively, 0.06 and 0.04, has the division performed well? B. Calculate the EVA of Division A (with the assumption that reported profits have already been adjusted) . Based on this EVA, has this division performed well? C. Suppose you were CEO of this firm, how would you choose between ROS/ROA and EVA for evaluating this division?

Answer 1

Solution:

Given that

Firm has generated $847,000

Million worth $24

The cost of capital firm is 9%

Invested 7.3 million.

A) The Return on Sales (ROS) for Division A:

ROS = Net Profit / Total Sales

ROS = $847,000 / $24,000,000

ROS = 0.0352

The Return on Assets (ROA) for Division A:

ROA = Net Income / Total Assets

ROA = $ 847,000 / $32,000,000

ROA = 0.0264

From the following we can get that both ROS & ROA are lower than their hurdle rate of 0.06 & 0.04 respectively

This proves that the project is not running well and should be stopped.