QUESTION TWO

a) Division Y has reported annual operating profits of sh 402 million. This was after charging sh 6 million for the full cost of launching a new product that is expected to last three years. Division Y has a risk adjusted cost of capital of 11% and is paying interest on a substantial bank loan at 8%(not charged as an expense in the operating income above) . The historical cost of the assets in Division Y, as shown on its balance sheet, is sh 100 million, and the replacement cost has been estimated at sh 172 million. The prevailing tax rate is 30%.

Required:

i) The Economic Value Added for Division Y (12 marks)

ii) Calculate the company's residual income.