Sanderson Inc is a divisionalised company. Among its divisions are Division A and Division B which operate in different industries. The following data relate to the year ended 31 May 2020: The basis for appraising divisional manager performance is currently under review. At present, there is disagreement as to whether the return on investment, residual income or EVA is the better measure. The company regards research and training costs to be an investment in the medium-term (5 years) future of the company. Under EVA the discretionary expenditure will be capitalized and amortized over this period. For the sake of simplicity assume that Income Statement Information Div. A Div. B (R 000’s) (R 000’s) Sales 726 576 414 400 Gain on sale of plant 0 15 984 726 576 430 384 Direct labor 142 400 127 200 Direct materials 409 600 163 200 Research and Training costs 11 200 17 600 Divisional overheads 84 800 72 800 Interest Expense 8 000 3 200 656 000 384 000 Net Profit before tax 70 576 46 384 Statement of Financial Position information Div. A Div. B (R 000’s) (R 000’s) Fixed assets (at cost less accumulated depreciation) 122 000 144 000 Inventory 101 600 28 800 Trade debtors 64 000 33 600 Cash at bank 24 000 17000 Total Assets 311 600 223 400 Equity and Long Term Liabilities Equity 173 600 124 200 Long Term liabilities 80 000 52 800 Current Liabilities Short term portion of long-term loan 10 000 12 000 Accounts payable 48 000 34 400 Total Equity and Liabilities 311 600 223 400

discretionary expenditure is incurred at the beginning of the year. The cost of capital of the company is 13% per annum.

Required:

1 Calculate for both divisions the following three measures: return on investment (ROI), Residual Income & EVA. 

2 State the advantages and disadvantages of Return on investment (ROI) and Residual Income.

Answer rating: 100% (QA)

1Return on Investment ROI Division A ROI Net Profit before Tax Interest Expense Average Total Assets ... View the full answer