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# Question: Performance Auto Company operates a New Car

Performance Auto Company operates a New Car Division (that sells high-performance sports cars) and a Performance Parts Division (that sells performance improvement parts for family cars). Some division financial measures for 2015 are as follows:

Required: 1. Calculate return on investment for each division using operating income as a measure of income and total assets as a measure of investment. 2. Calculate residual income for each division using operating income as a measure of income and total assets minus current liabilities as a measure of investment. 3. William Abraham, the New Car Division manager, argues that the Performance Parts Division has â€œloaded up on a lot of short-term debtâ€ to boost its RI. Calculate an alternative RI for each division that is not sensitive to the amount of short-term debt taken on by the Performance Parts Division. Comment on the result. 4. Performance Auto Company, whose tax rate is 40%, has two sources of funds: long-term debt with a market value of \$18,000,000 at an interest rate of 10%, and equity capital with a market value of \$12,000,000 and a cost of equity of 15%. Applying the same weighted-average cost of capital (WACC) to each division, calculate EVA for each division. 5. Use your preceding calculations to comment on the relative performance of each division

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A В New Car Performance 1 Division Parts Division 2 Total assets 3 Current liabilities 4 Operating income 5 Required rate of return \$33,000,000 \$ 6,600,000 \$ 2,475,000 12% \$28,500,000 \$ 8,400,000 \$ 2,565,000 12%