7.

1 Business Unit Financial Statements

Balance Sheet
($000s)
Current Assets
Cash
50
Receivables
150
Inventory
200
Total Current Assets
400
Fixed Assets
Cost
600
Less : Depreciation
-300
Book value
300
Total Assets
700
Revenues
Expenses except Depreciation
850
Depreciation
50
Total Expenses
Income before taxes
Capital charge (500 @10% )
Economic Value Added
Return on Investment : 100/500 = 20%

Current Liabilities
Accounts payable
Other current liabilities
Total Current Liabilities
Corporate Equity

90
110
200
500

Total Equities

700
1000
900
100
50
50

7.3 Incorrect Motivation for Asset Acquisition

($000s)
A. Economic Calculation
Investment in machine
100
Life 5 years
Cash inflow $27,000 per
year
Present Value of cash flow
102.4
($27,000 x 3.791 )
Net Present value
2.4
Decision : To acquire the machine
B. As reflected on business units Income Statement
As in 7.1
Revenue
Expenses except
Depreciation
850
Depreciation
50
Total
Income before taxes
Less : Capital charge
@10%
EVA

1000

First year
with Machine
1000

823
70
900
100
50

893
107
60

50

47

7.4 Effect of Acquisition on Reported Annual Profits ($000s )

Year Book Value Incremental
Capital
EVA
At Begin of
Income *
Charge +
year
a
b
c
b-c
1
100
7
10
-3
2
80
7
8
-1
3
60
7
6
1
4
40
7
4
3
5
20
7
2
5
Note : True return = approximately 11 per cent
* $27,000 cash inflow - $20,000 Depreciation = $7000 .
+ 10 per cent of beginning book value

ROI
b/a
7%
9
12
18
35

7.5 Profitability Using Annuity Depreciation Smoothing EVA ( $000)

Year
Beginning
Cash
EVA*
Capital
Depreciation
Book value Inflow
Charge +
#
1
$100
$27.0
$0.6
$10.0
$16.4
2
83.6
27.0
0.6
8.4
18.0
3
65.6
27.0
0.6
6.6
19.8
4
45.8
27.0
0.6
4.6
21.8
5
24.0
27.0
0.6
2.4
24.0
Total
$135
$3.0
$32.0
100.0
7.6 Profitability Using Annuity Depreciation Smoothing ROI ( $000)
Year
Beginning
Cash
Net Profit* Depreciation Return on
Book value Inflow
+
Beginning
Investment
1
2
3
4
5
Total

$100
83.6
65.6
45.8
24.0

$27.0
27.0
27.0
27.0
27.0
$135

11.0
9.2
7.3
5.1
2.4
35.0

16.0
17.8
19.7
21.9
24.6
100.0

Valuation of Plant and Equipment

Gross book value

Net book value
Replacement cost

Percentage of Respondents using this method

USA
Holland
India
6%
9%
17%
93
73
79
1
18
4
100
100
100

11%
11
11
11
10
10 %

7.8 Effect of Leasing Assets

Revenue
Expenses other
than below :
$850
Depreciation
50

Income Statement ($000)

As in Exhibit 3
$1000
$850

Rental expense Income before

taxes
Capital charge
EVA

60
900
100

$500x10%
$200x10%

If assets are leased

$1000

910
90

50
50

20
70

EXHIBIT 7.12 :
Difference between ROI and EVA
Business Unit

Cash

Receivable

Inventories

Fixed Assets

Total
investment

Budgeted
Profit

A
B
C
D
E

$10
20
15
5
10

$ 20
20
40
10
5

$30
30
40
20
10

$ 60
50
10
40
10

$120
120
105
75
35

$24.0
14.4
10.5
3.8
(1.8)

Business
Unit
A
B
C
D
E

(1)
Profit
Potential
24.0
14.4
10.5
3.8
(1.8)

Current Assets
(2)
(3)
Amount
Rate
$60
79
95
35
25

4%
4
4
4
4

(4)
Required
Earnings
$2.4
2.8
3.8
1.4
1.0

(5)
Amount
$60
50
10
40
10

Fixed Assets
(6)
(7)
Rate
Required
Earnings
10%
$6.0
10
5.0
10
1.0
10
4.0
10
1.0

ROI
Objective
(6) / (5)
20%
12
10
5
(5)

Budgeted
EVA
$15.6
6.6
5.7
(1.6)
(3.8)