ELN Waste Management has a subsidiary that disposes of hazardous waste and a subsidiary that collects and disposes of residential garbage. Information related to the two subsidiaries follows:
Based on the limited information, which subsidiary is the best candidate for expansion?
| Hazardous Waste |
Residential Waste |
|||
| Total assets | $15,260,000 | $86,180,000 | ||
| Noninterest-bearing current liabilities | 3,290,000 | 13,320,000 | ||
| Net income | 1,930,000 | 6,610,000 | ||
| Interest expense | 1,389,000 | 8,100,000 | ||
| Required rate of return | 10% | 13% | ||
| Tax rate | 40% | 40% |
Calculate ROI for both subsidiaries
| Particular | Hazardous | Residential |
| Waste | Waste | |
| Net income | 1,930,000 | 6,610,000 |
| Interest expense | 1,389,000 | 8,100,000 |
| 3,319,000 | 14,710,000 | |
| Less: Tax effect of Interest@40% | 555,600 | 3,240,000 |
| NOPAT | 2,763,400 | 11,470,000 |
| Total assets | $15,260,000 | $86,180,000 |
| Less noninterest-bearing current liabilities | 3,290,000 | 13,320,000 |
| Investment | 11,970,000 | 72,860,000 |
| ROI = NOPAT/Investment | 0.2309 | 0.1574 |
| ROI in Percetage | 0.2309 | 15.7400 |
2
Calculate EVA for both subsidiaries. Note that since no adjustments for accounting distortions are being made, EVA is equivalent to residual income.
EVA is equivalent to residual income. Hazardous Waste and Residential Waste
=NOPAT less cost of capital investment
=EVA
| Particular | Hazardous | Residential |
| Waste | Waste | |
| NOPAT | 2,763,400 | 11,470,000 |
| Investment | 11,970,000 | 72,860,000 |
| Required rate of return | 10% | 13% |
| Required return | 1,197,000 | 9,471,800 |
| EVA= NOPAT-Required Return | 1,566,400 | 1,998,200 |
3
Which subsidiary has added the most to shareholder value in the last year?
Answer:Residential Waste ,As measured in terms of EVA, Residential Waste has created the most shareholder value.
4
Based on the limited information, which subsidiary is the best candidate for expansion?
Answer
Based on the limited information, Hazardous Waste is the best candidate for expansion. Its current ROI is quite high suggesting it may be able to earn a higher rate of return on additional assets compared to Residential Waste
