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Income after interest and before taxes
$162,500
Income taxes ($162,500 × 20%)
32,500
Net income after taxes
$130,000
2. Investment = Total assets = $1,250,000
Income = Operating income = $200,000
ROI =
$200,000
$1,250,000
= 16%
3. Income = Operating income = $200,000
Imputed cost of investment = Investment ($1,250,000) × Required rate of return (10%)
= $125,000
Residual income = Income – Imputed cost of investment
= $200,000 – $125,000
= $75,000
4. a. Net operating profit after taxes = Operating income × (1 – Tax rate)
= $200,000 × (1 – 0.2)
= $160,000
b. Market value of debt = $600,000
After-tax cost of debt = 6.25% × (1 – Tax rate) = 6.25% × 80% = 5%
Market value of equity = $400,000 × 2 = $800,000
Cost of equity capital = 12%
Weighted-average cost of capital =
(5% $600,000) (12% $800,000)
$600,000 $800,000
+
+
= 9%
c. Investment = Total Assets – Current Liabilities = $1,250,000 – $250,000 = $1,000,000
Therefore, EVA = $160,000 – 9% × $1,000,000 = $70,000.
23-21 (25 min.) Goal incongruence and ROI.
McCall Corporation manufactures furniture in several divisions, including the patio furniture
division. The manager of the patio furniture division plans to retire in two years. The manager
receives a bonus based on the division’s ROI, which is currently 10%.
