Question

EKPN Company has two investment centre divisions, Winnipeg and Regina. EKPN’s strategy is developing innovative manufacturing solutions to meet its customers’ needs. EKPN also prides itself on delivering its innovative solutions in a timely fashion. The following information pertains to the 2019 year:

	Winnipeg	Regina
Revenues	$3,360,000	$1,680,000
Current liabilities	$216,000	$120,000
Operating income	$300,000	$96,000
Average operating assets	$2,160,000	$1,080,000
After tax operating income	$204,000	$69,600
Total capital employed	$1,860,000	$960,000
Actual cost of capital	9%	9%

The Winnipeg division has the opportunity to invest in some innovative technology to help design manufacturing solutions. The proposed investment would add operating income of $28,800 and would require additional computer equipment of $240,000. Currently, EKPN uses ROI to evaluate the performance of its Divisions.

Required: (round to 4 decimal places)

a)         Calculate the ROI (version 2) for each division for 2019.

b)         As the manager of the Winnipeg division would you invest in the innovative technology project? Show calculations to support your response.

c)         EKPN is considering changing from ROI to EVA to evaluate Divisional performance. Calculate the EVA for each division.

d)         Discuss at least one advantage and one disadvantage of using EVA versus ROI as a performance measure.

e)         List the 3 non-financial perspectives of the balanced scorecard and provide, with explanation, one performance measure for each perspective that would be suitable for EKPN’s divisions.

Answer 1

a) Return on Investment (ROI) = Net Operating Income/Average Operating Assets*100

Winnipeg Regina

Operating Income $ 300,000 $ 96,000

Average Operating Assets $ 2,160,000    $ 1,080,000

Return on Investment $ 300,000/$2,160,000*100 $96,000/$ 1,080,000*100

=13.89 %    =8.89 %

Therefore ROI for Winnipeg is 13.89% and for Regina is 8.89%

b) Calculation of Return of Investment after investment in Innovative Technology project in Winnipeg

Increase in Operating Income after investment = $28,800

Total Operating Income (A) = $ 300,000 + $ 28,800=$328,800

Increase in Operating assets after investment = $ 240,000

Total Operating Assets after Investment (B) = $ 2,160,000+$ 240,000= $ 2,400,000

Return on Investment (A/B) = $328,800/$2,400,000*100 = 13.70%

There is no increase in the rate of return after the investment of new innovative technology in Winnepeg division instead there is a slight decrease in ROI.As a manager I would not suggest the new investment in Winnipeg.

c) Economic Value Added = Net operating profit after tax - (CapitalEmployed*Cost of Capital)

Winnipeg Regina

Net Operating Income after tax $ 204,000   $69,600

Capital Employed $1,860,000   $960,000

Cost of Capital   9%    9%

Economic Value Added(EVA) = $204,000 - ($1,860,000*9%)    = $69,600 - ($960,000*9%)   

=$36,600 = - $16,800  

Therefore EVA of Winnipeg division is $36,600 and that of Regina division is -$16,800

d)

Return on Investment (ROI)

Advantage : It is a simpliest measurement for an investor to measure his return from his investment and to evaluate different investment options.

Disadvantage: One major disadvantage of using this ratio is it completly ignores time value of money.

Economic Value Added (EVA)

Advantage : It considers all the costs including cost of capital for calculation which makes it better indicator when compared to Return on Investment

Disadvantage : Major disadvantage is it involves in complex calculations when compared to ROI.