Benson Ltd operates a Car Division (that sells high-performance sport cars) and a Parts Division (that sells
Question:
Benson Ltd operates a Car Division (that sells high-performance sport cars) and a Parts Division (that sells performance-improvement parts for family cars). The company’s required rate of return is 8%. Some divisional financial measures for the current quarter are as follows:
Car Division | Parts Division | |
|---|---|---|
Total assets | $ 3,300,000 | $ 2,850,000 |
Current liabilities | $ 660,000 | $ 840,000 |
Operating profit | $ 247,500 | $ 256,500 |
Required:
(a) Calculate the return on investment (ROI) for each division using total assets as a measure of invested capital.
(b) Calculate the residual income (RI) for each division using total assets minus current liabilities as a measure of invested capital.
(c) The Car Division manager argues that the Parts Division has ‘loaded up 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 divisions. Comment on the result.
(d) Benson Ltd has two sources of funds: long-term debt with a market value of $1,800,000 at an after-tax interest rate of 6%, and equity capital with a market value of $1,200,000 and a cost of equity of 12%. The company tax rate is 30%. Calculate the economic valued added (EVA) for each division.
(e) Are the measures above consistent in comparing the performance of the two divisions?
Expert Answer:
a Calculate the return on investment ROI for each division using total assets as a measure of invested capital Solution Requirement Car Division Parts Division Return on Investment Net Operating Profi... View the full answer
