Cora Manufacturing makes fashion products and competes on th

Cora Manufacturing makes fashion products and competes on the basis of quality and leading-edge designs. The company has $2,500,000 invested in assets in its clothing-manufacturing division. The after-tax operating income from sales of clothing this year is $550,000. The cosmetics division has $11,000,000 invested in assets and an after-tax operating income this year of $1,650,000.

The income for the clothing division has grown steadily over the last few years. The WACC for Cora is 8%, and the previous period’s after-tax return on investment for each division was 13%. The chief executive officer (CEO) of Cora has told the manager of each division that the division that “performs the best” this year will get a bonus.

a.Calculate the ROI and the RI (using the WACC) for each division of Cora Manufacturing and briefly explain which manager will get the bonus. What are the advantages and disadvantages of each measure?

b.The CEO of Cora Manufacturing has recently heard of another measure similar to RI called EVA. The CEO has the accountant calculate EVA-adjusted incomes of clothing and cosmetics and finds that the adjusted after-tax operating incomes are $401,400 and $2,067,200, respectively. Also, the clothing division has $270,000 of current liabilities while the cosmetics division has only $120,000 of current liabilities. Using the preceding information, calculate EVA and discuss which division manager will get the bonus.

c.       What nonfinancial measures could Cora use to evaluate divisional performances?

Solution

(a)

ROI:

Clothing: 550,000/2,500,000 =22%

Cosmetics:1,650,000/11,000,000 =15%

Residual Income(RI)

Clothing:550,000 - (2,500,000*8%) =$ 350,000

Cosmetics: 1,650,000 - (11,000,000*8%) => $770,000

The residual Income in both cases is positive, and both departmenst able to cover their Income. But ROI of Clothing is higher than Cosmetics.So the mnageer of Clothing will get the Bonus.

(b)

EVA OF Clothing = 401,400 * 8% = $32,112

EVA OF Cosmetics = 2,067,200 * 8% => $165,376

Cosmetic divison manager will get the bonus beacuse EVA of Cosmetics are higher.

(c)

Cora Should evaluate following Non Financial measures for evaluation Performance of Division.