Colonial Pharmaceuticals is a small firm specializing in new

Colonial Pharmaceuticals is a small firm specializing in new products. It is organized into two divisions, which are based on the products they produce. AC Division is smaller and the life of the products it produces tend to be shorter than those produced by the larger SO Division. Selected financial data for the past year is shown below. Divisional investment is as of the beginning of the year. Colonial Pharmaceuticals uses a 8 percent cost of capital and uses beginning-of-the-year investment when computing ROl and residual income. Ignore income taxes AC Division SO Divisiorn Allocated corp Cost of goods sold Divisional investment R&D; Sales SG&A; S 640 3,280 9,800 2.400 9,600 820 S 1.400 5,000 76,000 3,600 18,000 1,130 . overhead R&D; is assumed to have a two-year life in the AC Division and a nine-year life in the SO division. All R&D; expenditures are spent at the beginning of the year. Assume there are no current liabilities and (unrealistically) that no R&D; investments had taken place before this year Required a. Compute EVA for the two divisions. (Do not round intermediate calculations.) Division SO Division Economic value added

Solution

AC Division

SO Division

Economic Value Added

$1,676

$790

Economic Value Added

Economic Value Added = Net Operating Income - [Invested Capital x Cost of capital]

Net Operating Income = Sales – [ Overhead + Cost of goods sold + R&D + SG&A]

Net Operating Income - AC Division

= $9,600 – [640 + 3280 + 2400 + 820] = $2,460

Net Operating Income - SO Division

= $18,000 – [1400 + 5000 + 3600 + 1130] = $6,870

Economic Value Added [EVA] – AC DIVISION

= $2,460 – [9,800 x 8%]

= $2,460 – 784

= $1,676

Economic Value Added [EVA] – AC DIVISION

= $6,870 – [76,000 x 8%]

= $6,870 – 6,080

= $790

	AC Division	SO Division
Economic Value Added	$1,676	$790