Return On Assets
Return on assets = net income
Total assets
Return on assets based on historical cost
| Division | (Net assets) Historical cost | (operating income
Historical cost |
Return on net assets |
| shoes | $15,000 | $2,700 | 0.18 or 18% |
| clothing | $45,000 | $6,750 | 0.15 or 15% |
| accessories | $30,000 | $4,800 | 0.16 or 16% |
| Total | 90,000 | 14,250 |
Return on assets based on replacement cost
| Division | (Net assets)
Replacement cost |
(operating income
|
Return on net assets |
| shoes | $15,000 | $2,700 | 0.18 or 18% |
| clothing | $55,000 | $6,150 | 0.11 or 11% |
| accessories | $48,000 | $3,900 | 0.08 or 8% |
| Total | 90,000 | 14,250 |
Residual income (RI)
Residual income = net operating income – (minimum rate of return on investment * operating assets)
Residual income based on historical cost (minimum required rate of return = 10%)
| Division | (Net assets) Historical cost | (operating income
Historical cost |
Residual income
($) |
| shoes | $15,000 | $2,700 | 1,200 |
| clothing | $45,000 | $6,750 | 2,250 |
| accessories | $30,000 | $4,800 | 1,800 |
| Total | 90,000 | 14,250 |
Residual income based on replacement cost (10% minimum required rate of return)
| Division | (Net assets)
Replacement cost |
(operating income
|
Return on net assets
($) |
| shoes | $15,000 | $2,700 | 1200 |
| clothing | $55,000 | $6,150 | 650 |
| accessories | $48,000 | $3,900 | (900) |
| Total | 90,000 | 14,250 |
Q2: based on the measures computed above,
Using Return on assets based on historical cost, the best performing department is shoes followed by accessories then clothing.
Using return on assets based on replacement cost, the best performing department is the shoes department followed by clothing and then accessories.
Using residual income based on historical cost, the best performing department is clothing department followed by accessories and lastly shoes.
Using return on assets based on replacement cost, the best performing department is the shoes department followed by accessories and lastly the clothing department.
Q3: for the divisions,
The return on assets show the efficiency of the company in the revenue generation from the assets it has. Hence for the divisions, the higher the rate of return on assets, the better that particular department utilizes its assets.
For the managers,
A division with a higher rate of return is an indication of how efficiently a manager can utilize the assets of that particular department to achieve profitability.
Managers being evaluated using residual income will be more likely to accept opportunities yielding return rates higher than the investment capital charge.
Economic value added for coca cola
Net operating income after taxes = 3,691,000,000-1,222,000,000 = 2,469,000,000
Cost of capital = 5%
Long term debt= 4,674,000,000
Cost of capital = 0.05 * 4,674,000,000 = 233,700,000
EVA = NOPAT – (Capital * Cost of Capital)
2,469,000,000 – [(0.30 * 4,674,000,000) * 0.12]
= 2300736000
Q2: EVA
According to Marshal et al. (2003), economic value added gives us a company’s true economic profit. It shows the ability of a company’s top management to maximize the wealth of its shareholders and investors.
References
Marshal, D.H, McManus, W.W., Viele, D. F. (2003) Accounting: What the Numbers Mean, 6th Edition. McGraw Hill Professional
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