Performance Auto Company operates a new car division (that sells high performance sports cars) and a...

 

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Performance Auto Company operates a new car division (that sells high performance sports cars) and a performance parts division (that sell performance improvement parts for family cars.) Some division financial measures for 2011 are as follows: New Car Performance Division Parts Division Total Assets $33,000,000 Current liabilities Operating Income Required rate of return $28,500,000 $8,400,000 $2,565,000 $6,600,000 $2,475,000 12% 12% 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, same criteria as above. 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 a 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 each division. Performance Auto Company operates a new car division (that sells high performance sports cars) and a performance parts division (that sell performance improvement parts for family cars.) Some division financial measures for 2011 are as follows: New Car Performance Division Parts Division Total Assets $33,000,000 Current liabilities Operating Income Required rate of return $28,500,000 $8,400,000 $2,565,000 $6,600,000 $2,475,000 12% 12% 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, same criteria as above. 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 a 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 each division.

Answer rating: 100% (QA)

1 New Car Performance Division Parts Division Total Assets 33000000 28500000 Current liabilities 660... View the full answer