Question

Mary’s Auto Shop Inc. allows its divisions to operate as autonomous units. Their results for the current year were as follows:

	Sport	Terrain	City
Revenues	$1,700,000	$800,000	$6,000,000
Current assets	230,000	40,000	410,000
Capital assets	870,000	660,000	1,590,000
Current liabilities	100,000	100,000	500,000
Net operating income	230,000	40,000	600,000
After-tax income	184,000	32,000	480,000
Weighted average cost of capital	10%	10%	10%

Required:

For each division compute (to two decimal) the:

1. Return on sales in %
2. Return on investment (to two decimal) based on total assets employed in %
3. Economic value added
4. Residual income based on net operating income

Answer 1

we will use following formulas

return on sales = net operating income/ net sales *100

Return on investment (to two decimal) based on total assets employed in % =Net operating income/ Total assets*100

economic value added= After tax income-[WACC*(Total assets-current liabilities)]

Residual income = operating income-(Required rate of return*Total assets)

	Sport	Terrain	City
Revenues (A)	$1,700,000	$800,000	$6,000,000
Current assets	$230,000	$40,000	$410,000
Capital assets	$870,000	$660,000	$1,590,000
Total assets (B)	$1,100,000	$700,000	$2,000,000
Current liabilities (E)	$100,000	$100,000	$500,000
Net operating income (c)	$230,000	$40,000	$600,000
After-tax income (d)	$184,000	$32,000	$480,000
Weighted average cost of capital	10%	10%	10%
(1) Return on sales (C)/(A) * 100	13.53%[$230,000/$1,700,000]*100	50%[$400,000/$800,000]*100	10%[$600,000/$6,000,000]
(2) Return on investment (to two decimal) based on total assets employed in %	20.91%[$230,000/$1,100,000]*100	57.14%[$400,000/$700,000]*100	30%[$600,000/$2,000,000]*100
EVA [d- (b-e)*10%]	$84,000[$184,000-($1,100,000-$100,000)10%]	-$28,000[$32,000-($700,000-100,000)*10%]	$330,000[$480,000-($2,000,000-$500,000)*10%]
Residual Income [C - (B*10%)	$120,000[$230,000-$1,100,000*10%]	$-30,000[$40,000 - ($700,000*10%)]	$400,000[$600,000-($2,000,000*10%)]

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