Question

Accelerate Auto Company operates a new car division (that sells high-performance sports cars) and a performance parts division (that sells performance improvement parts for family cars). Some division financial measures for 2012 are:



Required
1. Calculate ROI for each division using operating income as a measure of income and total assets as a measure of investment.
2. Calculate residual income (RI) for each division using operating income as a measure of income and total assets minus current liabilities as a measure of investment.
3. William Abraham, the New Car Division manager, argues that the performance parts division has “loaded up on a lot of short- term debt” to boost its RI. Calculate an alternative RI for each division that is not sensitive to the amount of short- term debt taken on by the performance parts division. Comment on the result.
4. Accelerate Auto Company, whose tax rate is 35%, has two sources of funds: long- term debt with a market value of $ 19,000,000 at an interest rate of 10%, and equity capital with a market value of $ 9,000,000 and a cost of equity of 14%. Applying the same weighted- average cost of capital (WACC) to each division, calculate EVA for each division.
5. Use your preceding calculations to comment on the relative performance of eachdivision.


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  • CreatedJanuary 15, 2015
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