Question

Jonsons is a national paint manufacturer and retailer. The

company is segmented into five divisions: Paint Stores (branded retail

locations), Consumer (paint sold through stores such as Walmart,

Home Hardware and Rona), Automotive (sales to auto manufacturers),

International, and Administration. The following is selected divisional

information for the company’s two largest divisions: Paint Stores and

Consumer (in thousands of dollars).

Division	Sales	Operating Income	Total Assets	Current Liabilities
Paint Stores	$3,920,000	$490,000	$1,400,000	$350,000
Consumer	$1,200,000	$180,000	$1,600,000	$600,000

Management is expecting a 20% target rate of return. The Company’s weighted average cost of capital (WACC) is 15% and its effective tax rate is 30%.

1. Calculate each division’s Return on Investment (ROI)

2. Compute each division’s Residual Income (RI)

3. Calculate each division’s Economic Value Add (EVA)

Answer 1

Answer:

	Paint Stores	Consumer
ROI (B/C)	35.00%	11.25%
Residual Income [B-(C*E)]	$          210,000	$        (140,000)
EVA [G-(C-D)*F]	$          185,500	$          (24,000)

Calculations:

ROI = Net Income / Total Assets * 100

Residual Income = Net Income (-) [Total assets * Target Rate]

EVA = NOPAT (-) [Total assets (-) Current Liabilities] * WACC

It is given that:

	Paint Stores	Consumer
Sales (A)	$       3,920,000	$      1,200,000
Income (B)	$          490,000	$         180,000
Total assets [C]	$       1,400,000	$      1,600,000
Current liabilities (D)	$          350,000	$         600,000
Target rate (E )	20%	20%
WACC (F)	15%	15%
NOPAT (B*0.7) (G)	$          343,000	$         126,000

So,

ROI (B/C)	35.00%	11.25%
Residual Income [B-(C*E)]	$          210,000	$        (140,000)
EVA [G-(C-D)*F]	$          185,500	$          (24,000)

In case of any doubt or clarification, feel free to come back via comments.