AQ-8
Blue Transport Company
Blue Transport Company operates a Truck Rental Division (that rents trucks to individuals) and a Transportation Division (that transports goods from one city to another). Some division financial measures for the year are as follows:
Truck Rental Division Transportation Division Total assets $ 11,000,000 $ 9,500,000 Current liabilities $ 2,200,000 $ 2,800,000 Operating Income $ 825,000 $ 855,000 Required rate of return 12 % 12%
Required:
1. Calculate return on investment (ROI) for each division using operating income as a measure of income and total assets as a measure of investment.
2. Calculate 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. Tony Red, the Truck Rental Division manager, argues that the Transportation Division has âloaded up on a lot of short-term debtâ to boost its RI. Calculate an alternative RI for each division that is not sensitive to the amount of short-term debt taken on by the Transportation Division. Comment on the result.
4. Blue, whose tax rate is 40%, has two sources of funds: long term debt with a market value of $9,000,000 at an interest rate of 10%, and equity capital with a market value of $6,000,000 and a cost of equity of 15%. Applying the same weighted average cost of capital to each division, calculate EVA for each division.
5. Use your preceding calculations to comment on the relative performance of each division.
AQ-8
Blue Transport Company
Blue Transport Company operates a Truck Rental Division (that rents trucks to individuals) and a Transportation Division (that transports goods from one city to another). Some division financial measures for the year are as follows:
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Required:
1. Calculate return on investment (ROI) for each division using operating income as a measure of income and total assets as a measure of investment.
2. Calculate 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. Tony Red, the Truck Rental Division manager, argues that the Transportation Division has âloaded up on a lot of short-term debtâ to boost its RI. Calculate an alternative RI for each division that is not sensitive to the amount of short-term debt taken on by the Transportation Division. Comment on the result.
4. Blue, whose tax rate is 40%, has two sources of funds: long term debt with a market value of $9,000,000 at an interest rate of 10%, and equity capital with a market value of $6,000,000 and a cost of equity of 15%. Applying the same weighted average cost of capital to each division, calculate EVA for each division.
5. Use your preceding calculations to comment on the relative performance of each division.
