Question MCS 2011 A company has two divisions Division A and Division B.

The financial details of Divs A and B for 2 years are given below: Div A Div A 2010 2011 Sales 500 400 Variable Cost 300 240 200 160 Fixed Cost 50 40 PBIT 150 120 Interest 30 11 PBT 120 109 Tax @40% 48 44 PAT 72 65 Balance Sheet Fixed Assets Net Current Assets 2010 400 200 600 2011 350 150 500

Div B 2010 600 360 240 80 160 30 130 52 78

2010 400 200 600

Management evaluates the performance of the Div Managers on the basis of Return on Total Assets (ROTA). Managerial compensation is linked to ROTA. Based on this criteria, the Div manager of Div A was given a higher incentive compensation as he has improved the ROTA of his Div. Manager of Div B felt it was unfair to judge him on this criteria. He had identified a new investment opportunity and improved the sales. He felt he should be judged on the basis of Economic Value Added, which directly contributes to the wealth of the shareholders. His Div has grown by 25% on sales and assets wheras Div A has contracted during this period both in sales and size of assets. Cost of equity is 10%. Economic Value Added can be calculated as [PAT - Cost of Equityin %* Equity Share Capital]. Calculate Return on Total Assets for both Div A and B for the year 2010 and 2011. Also calculate EVA for both Divs for the year 2010 and 2011. Discuss views raised by Manager of Div B, does judging Div Manager on ROI could lead to dysfunctional behaviour on their Part.

Div B 2011 800 480 320 120 200 40 160 64 96

2011 500 300 800

e year 2010 and 2011.