Question2 : Performance Measurement

Part A

A division at Signal Biomedical has the following information for 2019:

Marginal tax rate: 25%

Market yield on equivalent debt: 6%

Shareholders expect a rate of return equal to: 14%

EVA assets (before adjustments): $700,000

EVA total liabilities: $50,000 (of which $20,000 are current)

Debt-40%, Equity-60%

Required:

1) Based on the above information, calculate the WACC.

2) Biomedical's operating income before taxes was $90,000 ($10,000 of this was R&D expense and $5,000 expense was damages from a spring flood). Capitalized R&D is amortized over 5 years. What is Signal Biomedical's EVA?

Part B

Yahn Co reported operating income of $175,000 in January 2020.The following shows their balance sheet for January, 2020 month end.Their balance of operating assets at January 1, 2020 was $875,000.

Asset

Liabilities

Cash

200,000

Account Payable

175,000

Account receivable

30,000

Loan Payable

125,000

Inventory

20,000

Plant & Equipment

800,000

Goodwill

5,000

Equity

710,000

Accumulated Depreciation

45,000

The following investment opportunities are available to the division:

Investment

Opportunity

Income

Investment

1

$18,000

$200,000

2

80,000

600,000

3

110,000

500,000

4

40,000

200,000

The firm requires a minimum return of 13% on all investment opportunities which is consistent with the rate of return required by investors. The company's marginal tax rate is 25%.

Required:

1)If you are Yahn's manager and your performance bonus was evaluated only on ROI, based on the existing division ROI, which investment opportunity or opportunities would you be motivated to accept. Explain why. (3 marks)

2)If you were the division manager and your performance bonus was evaluated only on RI, which investment or opportunities would you be motivated to accept? (3 marks)

3)What is the most effective method of evaluating performance to motivate desired behaviour?