Question

Mark’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	$1,850,000	$920,000	$3,400,000
Current assets	268,000	155,800	1,255,000
Capital assets	1,250,000	430,000	890,000
Current liabilities	225,000	78,6000	795,000
Net operating income	228,000	250,000	350,000
After-tax income	159,600	175,000	245,000
Weighted average cost of capital	7%	7%	7%

Required:

For each division compute the

a.     return on sales

b.     return on investment based on total assets employed

c.     economic value added

d.     residual income based on net operating income

Answer 1

a. Computation of Return on Sales

Return on Sales = Operating Income/Revenue

Particulars		Sport	Train	City
Operating Income	A	$228,000	$250,000	$350,000
Revenue	B	$1,850,000	$920,000	$3,400,000
Return on sales	C=A/B	12.32%	27.17%	10.29%

b. Computation of ROI

ROI = Net operating Income/ Operating Assests

Particulars		Sport	Train	City
Net Operating Income	A	228,000	250,000	350,000
Operating Assets	B	1,518,000	585,800	2,145,000
		($268,000+$1,250,000)	($155,800+$430,000)	($1,255,000+$890,000)
ROI	C=A/B*100	15.02%	42.68%	16.32%

c. Computation of Economic Value Added

For Caluculating Economic Value Added, we will first have to calculate the capital employed which will be as follows:

Particulars		Sport	Train	City
Current assets	A	$268,000	$155,800	$1,255,000
Capital Assets	B	$1,250,000	$430,000	$890,000
Current Liabilities	C	$225,000	$78,600	$795,000
Capital Employed	D=A+B-C	$1,293,000	$507,200	$1,350,000

Economic Value Added = Net operating Income after tax- (Capital Invested*WACC)

Particulars		Sport	Train	City
Net operating Income after tax	A	159,600	175,000	$245,000
Capital Invested	B	1,293,000	507,200	1,350,000
WACC	C	7.00%	7.00%	7.00%
ROI	D=A-(B*C)	$69,090	$139,496	$150,500

d. Computation of the Residual Income

Residual Income = Net operating Income - (Average Assets Employed * Minimum Required Return)

Particulars		Sport	Train	City
Net Operating Income	A	$228,000	$250,000	$350,000
Average Operating Assets	B	$1,518,000	$585,800	$2,145,000
Minimum Required Return	C	7%	7%	7%
Residual Income	D=A-(B*C)	$121,740	$208,994	$199,850