Performance Auto Company operates a new car division (that sells high-performance sports cars) and a performance parts division (that sells performance-improvement parts for family cars). The financial measures for some divisions for 2014 are as follows:

Answer the following questions:

1. Calculate the return on investment (ROI) for each division, using the operating income as a measure of income and total assets as a measure of investment.

2. Calculate the 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 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) for each division, calculate EVA for each division.

5. Use your preceding calculations to comment on the relative performance of each division.

Bs Home I Insert Page Layout Formulas Data New Car Performance Division Parts Division $33,000,000 S28,500,000 S 6,600,000 S8,400,000 S 2,475,000 2,565,000 2 Total assets 3 Current liabilities 5 Required rate of return 12% 12%