Consider the following data, which relate to the two divisions of Office Products.
West DivisionEast Division
Total assets $51,000,000$28,000,000
Noninterest-bearing current liabilities 6,000,0003,500,000
Cost of capital8%10%
Compare the two divisions in terms of return on investment and residual income. In the past year, which division has created the most wealth for Office Product’s shareholders?
174.The Pastry Division of Cinotti’s BakeryreportedNOPAT totaling$512,000 in 2014.This included $330,000 in research and development costs for 2014.Additionally, research and development in 2013and 2012were, respectively, $280,000 and $240,000.Invested capital at the end of 2014 totaled $5,400,000. The companyis subject to a 30% income tax rate.Cinotti capitalizes andamortizes intangible assetsover 4years.The company’s cost of capital is 7 percent and its required rate of return is 8 percent. How much is EVA?
175.The Knob Division of Barnett Brass has NOPAT of $42,000. The company’s cost of capital is 5.5 percent, its required rate of return is 8.4 percent. The division’s invested capital totals $560,000. How much is the division’s residual income?
176.For fiscal year 2014, the Pharmacy Division of Halgreen RXreportednet income totaling$6,000,000. Its interest expense was $1,000,000, and the income tax rate was 40 percent. The total assets of the Pharmacy Division were $68,000,000, and total current liabilities were $7,000,000 with $3,200,000 being interest-bearing. The company’s cost of capital is 8 percent and its required rate of return is 9 percent. Calculate NOPAT, invested capital, and residual income for the Pharmacy Division and comment on the division’s contribution to the company’s performance.
177.Walk-In Care Center is a division of Shands Corporationand is organized as an investment center. In the past year, the Care Center reported an after-tax income of $760,000. Total interest expense was $70,000, and the center’s incometax rate is 35 percent. Its assets totaled $12,000,000, noninterest-bearing current liabilities were $900,000, and interest-bearing current liabilities totaled $600,000.Shands has established a required rate of return of9 percent, while its cost of capital is 6.4 percent.Calculate the residual income generated by Walk-In Care Center.
*178.Windsor Medical Services has two outpatient clinics and a pathology laboratory, which are organized as separate profit centers. When the pathology laboratory conducts tests ordered by the clinics, the clinics are charged the basic market price of the tests. The managers of the clinics object to this practice and argue that because they are all part of the same company, they should be charged for the cost of the procedures rather than market price. Support the use of market prices or cost-based prices for charging clinics for tests performed by the pathology laboratory.
179.Good Buy Electronics is considering a plan by which its managers will be evaluated and rewarded based on a measure of economic value added. Before adopting the plan, management wants you to calculate the projected amount of EVA for 2014, based on financial forecastsand prior financial data, as follows:
Noninterest-bearing current liabilities20,000,000
Research and development2,400,000
Income tax rate35%
Cost of capital7%
Required rate of return9%
Research and development expenditures in 2012and 2013were $1,200,000 and$2,100,000, respectively. Research and development is amortized over a three-year life.
a.Explain why it is important to capitalize research and development if managers are rewarded based on EVA.
b.Calculate forecasted EVA for 2014.
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