Eva Manufacturing makes fashion products and competes on the basis of quality and leading-edge designs. The company has $3,000,000 invested in assets in its clothing manufacturing division. After-tax operating income from sales of clothing this year is $600,000. The cosmetics division has $10,000,000 invested in assets and an after-tax operating income this year of $1,600,000. Income for the clothing division has grown steadily over the last few years. The weighted-average cost of capital for Eva is 10% and the previous period’s after-tax return on investment for each division was 15%. The CEO of Eva has told the manager of each division that the division that “performs best” this year will get a bonus.
REQUIRED
1. Calculate the ROI and residual income for each division of Eva Manufacturing, and briefly explain which manager will get the bonus. What are the advantages and disadvantages of each measure?
2. The CEO of Eva Manufacturing has recently heard of another measure similar to residual income called EVA. The CEO has the accountant calculate EVA-adjusted incomes of Clothing and Cosmetics, and finds that the adjusted after-tax operating incomes are $720,000 and $1,430,000, respectively. Also, the Clothing Division has $400,000 of current liabilities, while the Cosmetics Division has only $200,000 of current liabilities. Using the above information, calculate EVA, and discuss which division manager will get the bonus.
3. What nonfinancial measures could Eva use to evaluate divisional performances?