Performance Auto Company operates a new car division (that sells highperformance sports cars) and a performance parts division (that sells performance-improvement parts for family cars). Some division financial measures for 2017 are as follows:

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 using operating income as a measure of income and total assets minus current liabilities as a measure of investment.

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 \($18,000,000\) at 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.

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Home Insert Page Layout Formulas Data A B New Car 1 Division 2 Total assets 3 Current liabilities $33,000,000 $ 6,600,000 4 Operating income $ 2,475,000 5 Required rate of return 12% Performance Parts Division $28,500,000 $ 8,400,000 $ 2,565,000 12%