Question

ROI, Residual Income, and EVA with Different Bases Envision Company has a target return on capital of 12 percent. The following financial information is available for October ($ thousands):

Software Division . Consulting Division Venture Capital Division

(Value Base) (Value Base) (Value Base)

Book Current Book Current Book Current

Sales $100,000 $100,000 $200,000 $200,000 $800,000 $800,000

Income 12,250 11,700 16,400 20,020 56,730 51,920

Assets 70,000 90,000 100,000 110,000 610,000 590,000

Liabilities 10,000 10,000 14,000 14,000 40,000 40,000

Required

a. Compute the return on investment using both book and current values for each division. Round answers to three decimal places.

Book Value Current Value

Software Answer ? Answer ?

Consulting Answer ? Answer ?

Venture Capital Answer ? Answer ?

b. Compute the residual income for both book and current values for each division. Use negative signs with answers, when appropriate.

Book Value Current Value

Software $Answer 3,850 $Answer 900

Consulting Answer 4,400 . Answer 6,820

Venture Capital Answer (16,470) Answer (1,880)

c. Compute the economic value added income for both book and current values for each division if the tax rate is 30 percent and the weighted average cost of capital is 10 percent. Use negative signs with answers, when appropriate. Book Value Current Value

Software $Answer ? $Answer ?

Consulting Answer ? Answer ?

Venture Capital Answer ? Answer ?

Answer 1

a. ROI = income / Assets

Book Value Current Value

Software Division 0.175 0.13

Consulting Division 0.164 0.182

Venture Capital Division 0.093 0.088

Workings:

i. Book value

Software Division = 12,250/70,000=0.175

Consulting Division = 16,400/100,000=0.164

Venture Capital Division = 56,730/610,000 =0.093

ii. Current value

Software Division = 11,700/90,000=0.13

Consulting Division = 20,020/110,000=0.182

Venture Capital Division= 51,920/ 590,000=0.088

b. Residual income = Income - {Asset x Return on capital 12% }

Book Value Current Value

Software Division 3850 900

Consulting Division 4400 6820

Venture Capital Division -16470 -18880

Workings:

i. Book value

Software Division = 12,250-(70,000*12%)=3850

Consulting Division = 16,400-(100,000*12%)=4400

Venture Capital Division = 56,730-(610,000*12%) =-16470

ii. Current value

Software Division = 11,700-(90,000*12%)=900

Consulting Division = 20,020-(110,000*12%)=6820

Venture Capital Division= 51,920-(590,000*12%)=-18880

c. Economic Value Added ( EVA ) = Net Income After Tax - ( Amount of Capital x Weighted Average Cost of Capital [WACC] )

C. Software Division

(Value Base)

Book Current

Sales 100,000 100,000

Income 12,250 11,700

Assets 70,000 90,000

Liabilities 10,000 10,000

Capital invested 60,000 80,000

(Asset - Liabilities)

Tax on Income(30%) 3675 3510

Income after Tax 8,575 8,190

(Income - Tax on

income) (A)

Capital invested 6,000 8,000

* WACC - 10% ) (B)

EVA (C)=(A)-(B) 2,575 190

Consulting Division

(Value Base)

Book Current

Sales 200,000 200,000

Income 16,400 20,020

Assets 100,000 110,000

Liabilities 14,000 14,000

Capital invested 86,000 96,000

(Asset - Liabilities)

Tax on Income(30%) 4920 6006

Income after Tax 11,480 14,014

(Income - Tax on

income) (A)

Capital invested 8,600 9,600

* WACC - 10% ) (B)

EVA (C)=(A)-(B) 2,880 4,414

Venture Capital Division

(Value Base)

Book Current

Sales 800,000 800,000

Income 56,730 51,920

Assets 610,000 590,000

Liabilities 40,000 40,000

Capital invested 570,000 550,000

(Asset - Liabilities)

Tax on Income(30%) 17019 15576

Income after Tax 39,711 36,344

(Income - Tax on

income) (A)

Capital invested 57,000 55,000

* WACC - 10% ) (B)

EVA (C)=(A)-(B) -17,289 -18,656