Question

Heather Smith Cosmetics (HSC) manufactures a variety of products and is organized into three divisions (investment centers): soap products, skin lotions, and hair products. Information about the most recent year’s operations follows. The information includes the value of intangible assets, including research and development, patents, and other innovations that are not included on HSC’s balance sheet. Were these intangibles to be included in the financial statements (as they are for EVA®), the increase in the balance sheet and the increase in after-tax operating income would be as given below: Division Operating Income Average Total Assets Value of Intangibles Intangibles’ Effect on Income Soap products $ 3,244,000 $ 59,994,000 $ 1,494,000 $ 994,000 Skin lotions 2,744,000 32,994,000 7,994,000 5,994,000 Hair products 4,994,000 54,994,000 994,000 694,000 Minimum desired rate of return 5.00 % Cost of capital 4.00 % Required: 1. Calculate the return on investment (ROI) for each division. (Round your answers to 2 decimal places. (i.e. .1234 = 12.34%)) 2. Calculate the residual income (RI) for each division. 3. Calculate EVA® for each division.

Answer 1

Answer and Explanation:

The computation is shown below:

1. Return on investment

As we know that

Return on investment = Operating income  ÷ Average total assets

Particulars    Soap Products              Skin Lotions                 Hair products

Return on investment  5.41%              8.32%                            9.08%

($3,244,000 ÷ $59,994,000)  ($2,744,000 ÷ $32,994,000)  ($4,994,000 ÷ $54,994,000)

2. Residual income

Residual income = Operating income - (Average total assets × Minimum desired rate of return)

Particulars    Soap Products              Skin Lotions                 Hair products

Return on investment  $244,300       $1,094,300                 $22,443,000

{$3,244,000 - ($59,994,000 × 5%)}  {$2,744,000 - ($32,994,000 × 5%)}  {$4,994,000 - ($54,994,000 × 5%)}

3. EVA

EVA = Operating income - (Average total assets × Cost of capital)

Particulars    Soap Products              Skin Lotions                 Hair products

Return on investment  $844,240    $1,424,240                   $2,794,240

{$3,244,000 - ($59,994,000 × 4%)}  {$2,744,000 - ($32,994,000 × 4%)}  {$4,994,000 - ($54,994,000 × 4%)}