Name: Nurul Sari NIM: 1101002048 Case 7.1 ; 7.2 ; 7.7 Case 7.1 : Investment center Problems (A)
The ABC Company has three division (A,B,C). Division A eclusively a marketing division. Division B exclusively a manufacturing division and Division C is both a manufacturing aand marketing division. The following are the financial facts for each of these divisions: Current Assets Fixed Assets Total Assets Profit befor depreciation and market development cost
Division A $ 100.000 $ $ 100.000 $ 200.000
Division B $ 100.000 $ 1.000.000 $ 1.100.000 $ 200.000
Division C $ 100.000 $ 500.000 $ 600.000 $ 200.000
Assume that the ABC Company depreciates fixed assets on a SLM over 10 years. To maintain its market and productive facilities, it has to invest $100,000 per year in market development in Division A and $50,000 per year in Division C. This is written off as an expense. It also has to replace 10% of its productive facilities each year. Under this equilibrium conditions, what are the annual rates of return earned by each of the division? Answer:
Profit befor depreciation and market development cost Less: Depreciation Less: Mrket Development Cost Net Profit Total Assets ROI = (Net Profit/Total Assets)*100
$ $ $ $
A 200.000 0 100.000 100.000 100.000 100,00%
$ $ $ $ $
Division B 200.000 100.000 100.000 1.100.000 9,09%
$ $ $ $ $
C 200.000 50.000 50.000 100.000 600.000 16,67%
Case 7.2 : Investment Center Problems (B)
Current Assets Fixed Assets Total Assets Gross Profit From Sales
Layout and Marketing $ 200.000 $ $ 200.000 $ 400.000
Office Furniture $ 200.000 $ 1.000.000 $ 1.200.000 $ 400.000
Office Supplies $ $ $ $
200.000 500.000 700.000 400.000
Total $ 600.000 $ 150.000 $ 150.000 $ 300.000 $ 1.800.000 16,67%
Name: Nurul Sari NIM: 1101002048 Case 7.1 ; 7.2 ; 7.7 The Complete Office Company depreciates all of its fixed assets over 10 years on SLM, and its calculates ROA on beginning of year gross book value of assets. The operating expense for each division (besides depreciation on fixed assets) are $200,000 for Layout and Marketing, $100,000 for Office Furniture, and $150,000 for Office Supplies. Please compute a ROA figure for each divisions for 1997 Answer: Layout and Marketing $ 400.000 $ 200.000 $ 200.000 $ 200.000 100,00%
Gross profit from sales Less: Operating Expense Net Profit Total Assets ROI = (Net Profit/Total Assets)*100
$ $ $ $
Division Office Furniture 400.000 100.000 300.000 1.200.000 25,00%
Office Supplies $ $ $ $
400.000 150.000 250.000 700.000 35,71%
Case 7.7 : Marden Company
Cash AR Inventory Total Current Assets
$ 100 $ 800 $ 900 $ 1.800
AP Total Current Liabilities
$ $
400 400
Debt
$
700
PPE, Cost Depreciation (SLM) PPE net Total Assets
$ 1.000 $ 400 $ 600 $ 2.400
Equity
$ $
1.300 2.000
Total Equities
$
2.400
Sales Cost Other than those list below
$ 4.000 $ 3.200,00
Depreciation Allocated Share of Corporate expense Income before income tax
$ 100,00 $ 100,00 $ 600,00
Total $ 1.200.000 $ 450.000 $ 750.000 $ 2.100.000 35,71%
Name: Nurul Sari NIM: 1101002048 Case 7.1 ; 7.2 ; 7.7 Recommended the best way of measuring the performance of the division manager. If you need additional information, make the assumption you believe to be most reasonable. Answer: Major Ratios ROE ROA ROIC Profitability Ratios Profit Margin Gross Margin Turnover and Control ratios PE ratio Asset Turnover Fixed Asset Turnover Inventory Turnover Collection Period Day's sales in cash Payable period Leverage and Liquidity Ratios Assets to Equity Debt to Assets Debt to Equity Times Interest Earned Times Burden Covered Current Ratio Acid Test
46,15% 25,00%
15,00% 20,00% Market price/after tax income 1,67 6,67 5,00
184,62% 45,83% 84,62% 9,52 450,00% 2.25
There are many methods to evaluate the performance of each division. We can use profitability ratios, liquidity ratio and debt ratio and so on to do the measurement. Just like many big company in the world, ROI, the indicator of money gained or lost on an investment relative to the amount of money invested, is the most popular way to do the measurement. However, in my opinion, EVA or RI should be a better method to evaluate the performance of each division separately. Let use EVA to explain the reason of EVA being a better approach. EVA is net operating profit after taxes less the money cost of capital. If the company uses ROI to measure the performance, it cannot maximize the shareholder’s value. When there is a project which will increase the value of the company but will decrease the ROI result, the manager will cancel it. But if
Name: Nurul Sari NIM: 1101002048 Case 7.1 ; 7.2 ; 7.7 we use EVA method, we just need to calculate the capital cost rate. In addition, each investment has different capital cost. EVA method can use different interest rate for each investment. The most important reason is it can encourage division managers to do their best to add value for the whole company. After all, when the top manager measures the performance for each division, he should consider not only the value added for each department because of the different size, but also the trend of weight for total value added.
