ROI, RI, EVA®. (D. Solomons, adapted) Consider the following data for the two geographi¬

cal divisions of the Potomac Electric Company that operate as profit centres:

Atlantic Pacific Division Division Total assets $1,200,000 $6,000,000 Current liabilities 300,000 1,800,000 Operating income 240,000 900,000 Required 1. Calculate the return on investmerit (ROI) using operating income as the measure ofincome and using total assets as the measure ofinvestment.

2. Potomac Electric has used residual income as a measure of management success, the vari¬

able it wants a manager to maximize. Using this criterion, what is the residual income for each division using operating income and total assets if the required rate of return on investment is 12 %?

3. Potomac Electric has two sources offunds: long-term debt with a market value of $4,200,000 and an interest rate of 10%, and equity capital with a market value of $4,200,000 at a cost of equity of 14%. Potomac’s income tax rate is 40%. Potomac applies the same weightedaverage cost of capital to both divisions, since each division faces similar risks. Calculate the economic value added for each division. Which ofthe measures calculated in requirements 1, 2, and 3 would you recommend Potomac Electric use? Why? Explain briefly.