MCS Q7, Nov 2012

XYZ

XYZ Company's Controller uses Economic Value Added (EVA) method to measure divisional profit performance of its three divisions X, Y and Z. Company charges to divisions 5% for current assets and 10% for fixed assets while computing EVA. nformation on performance is given below: Div X Budget 180 200 800 1000 Div X Actual 160 180 800 980 Div Y Budget 110 400 800 1200 Div Y Actual 120 380 900 1280

Profit Current Assets Fixed Assets Investment

On the basis of information given (Rs. crores) (1) Tabulate budgeted and actual return on assets for each of the three divisions. (2) Tabulate budgeted and actual economic value added for each division. (3) Comment on the two methods based on the tabulations.

Div Z Budget 100 600 1000 1600

Div Z Actual 100 700 1100 1800

MCS Q7, Nov 2012

XYZ Div X Budget 180 200 800 1000 Div X Actual 160 180 800 980 Div Y Budget 110 400 800 1200 Div Y Actual 120 380 900 1280 Div Z Budget 100 600 1000 1600 Div Z Actual 100 700 1100 1800

Profit Current Assets Fixed Assets Investment ROI: Profit Investment ROI EVA: Profit Charge on Current Assets @ Charge on Fixed Assets @ Total charge on Assets Total charge on Assets/Investment EVA % of Div to Company Actual EVA minus Budgeted EVA EVA/ Investment 5% 10%

180 1000 18.00%

160 980 16.33%

110 1200 9.17%

120 1280 9.38%

100 1600 6.25%

100 1800 5.56%

180 10 80 90 9.00% 90 129% 9.00%

160 9 80 89 9.08% 71 79% 192% (19.00) 7.24%

110 20 80 100 8.33% 10 14% 0.83%

120 19 90 109 8.52% 11 110% 30% 1.00 0.86%

100 30 100 130 8.13% -30 -43% -1.88%

100 35 110 145 8.06% -45 150% -122% (15.00) -2.50% 70

Conclusions:

1 Divisions X and Y are adding value to the company, but Div Z is destroying shareholder wealth. As per budget, Div X and Div Y add value of Rs. 90 crores and Rs. 10 crores resp., but Div Z loses value of Rs. 30 crores. As per actuals, Div X and Div Y add value of Rs. 71 crores (79% of the budget and and Rs 10 crores (110% of the budget). Div Z is actually losing value of Rs. 45 crores against losing vale of Rs. 30 crores as per budget. 2 Div X: Actual ROI was lower at 16.33% compared to budgeted ROI of 18.0%. Also, the Actual EVA of Rs. 71 crores was lower than the budgeted EVA of Rs. 90 crores. Thus the results from ROI and EVA are matching comments on performance: Div X provides the highest EVA amongst all the three divisions. Although the performance of the Division X has provided EVA of Rs. 71 crores, it is lower than the budgeted EVA of Rs. 90 crores. Thus, Div X's operations add the highest value to the company,yet there is need to improve the profitability to come upto the budgeted levels. 2 Div Y: Actual ROI was marginally higher at 9.38% compared to budgeted ROI of 9.17%. Also, the Actual EVA of Rs. 11 crores was marginally higher than the budgeted EVA of Rs 10 crores. Thus the results from ROI and EVA are matching comment on operations: The inherent profitability (both ROI and EVA) of Div Y are not encouraging, but the division has performed slightly better than the budget, and added value to the company. The EVA of Rs. 11 crores is adding value to the company.

3 Div Z: Budgeted ROI is low at 6.25% and the actual ROI is lower at 5.56%. The budgeted EVA is minus Rs. 30 crores, which is very adverse, and the actual performance is still worse indicating actual EVA of minus Rs. 45 crores. comment on operations: Div Z: The budgeted and actual EVA of DivZ shows that the division will destroy shareholder wealth by Rs. 30 crores and Rs. 45 crores resp. The management shoulf therefore immediately consider closing the Division Z.

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