ROI, RI, EVA. Performance Auto Company operates a New Car

ROI, RI, EVA. Performance 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 2008 are as follows:

New Car Performance Division Parts Division Total assets $33,000,000 $6,600,000 $28,500,000 Current liabilities $ 8,400,

1. Calculate return on investment (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. Performance Auto Company, whose tax rate is 40%, has two sources of funds: long-term debt with a market value of $18,000,000 at an interest rate of 10%, and equity capital with a market value of $12,000,000 and a cost of equity of 15%. 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.

Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of...
Cost Of Equity
The cost of equity is the return a company requires to decide if an investment meets capital return requirements. Firms often use it as a capital budgeting threshold for the required rate of return. A firm's cost of equity represents the...

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