Question

Axel Corporation (which has a weighted-average cost of capital of 12%) has two divisions with the following information:

	Beta Division	Cal Division
Total Assets	$720,000	$550,000
Current Liabilities	$220,000	$110,000
After-Tax Operating Income	$105,000	$110,000
ROI	15%	20%

Which of the following is true?

Multiple Choice

• Beta is more profitable and has a higher EVA than Cal.

• Beta is more profitable than Cal, but Cal is generating a greater return relative to its resources than Beta.

• Beta has a lower ROI but a higher EVA than Cal.

• Cal is more profitable than Beta, but Beta is generating a greater return relative to its resources than Cal.

Answer 1

Computation of Capital Employed and Finance Charge:
Particulars	Beta Division	Cal Division
Capital Employed (CE):
Total Assets	$    720,000.00	$     550,000.00
Less: Current liabilities	$    220,000.00	$     110,000.00
a. Capital Employed:	$    500,000.00	$     440,000.00
b. Weighted average cost of capital(WACC)	12%	12%
Finance charge = CE*WACC	$      60,000.00	$      52,800.00
Computation of Economic value added:
Particulars	Beta Division	Cal Division
Net operating income after tax (NOPAT)	$    105,000.00	$     110,000.00
Less: Finance Charge	$       60,000.00	$       52,800.00
Economic value added =NOPAT-Finance Charge	$      45,000.00	$      57,200.00

Calculation of Return on investment
Particulars	Beta Division	Cal Division
Amount of investment	$    720,000.00	$     550,000.00
ROI %	15%	20%
Return on investment	$    108,000.00	$    110,000.00

Correct Answer: Cal division is more profitable than Beta because Cla Division operating income of $110,000 is more than Beta Division operating income of $105,000, But Beta is generating a greater return relative to its resources than Cal division.

Wrong Answers:

1. Beta Division is more profitable and has a higher EVA than Cal Division: From the above calculations Beta division is not profitable and has lesser EVA than Cal division.

2. Beta is more profitable than Cal, but Cal is generating a greater return relative to its resources than Beta division: From the above calculations Beta division is not profitable, but Cal division is generating a greater return relative to its resources than Beta division.

3. Beta division has a lower ROI but a higher EVA than Cal division: From the above calculations Beta division has a lower ROI but a Lower EVA than Cal division