Question

Megatronics Corporation, a massive retailer of electronic products, is organized in four separate divisions. The four divisional managers are evaluated at year-end, and bonuses are awarded based on ROI. Last year, the company as a whole produced a 15 percent return on its investment.

During the past week, management of the company’s Northeast Division was approached about the possibility of buying a competitor that had decided to redirect its retail activities. (If the competitor is acquired, it will be acquired at its book value.) The data that follow relate to recent performance of the Northeast Division and the competitor:

	Northeast Division					Competitor
Sales		$	4,400,000				$	2,690,000
Variable costs			75	% of sales				70	% of sales
Fixed costs		$	913,000				$	755,000
Invested capital		$	850,000				$	200,000

Management has determined that in order to upgrade the competitor to Megatronics’ standards, an additional $125,000 of invested capital would be needed.

Required:

1. 1. Compute the current ROI of the Northeast Division and the division’s ROI if the competitor is acquired.

2. 2. If divisional management is being evaluated on the basis of ROI, will the Northeast Division likely pursue acquisition of the competitor?

3. 3-a. Compute the ROI of the competitor as it is now and after the intended upgrade.

4. 3-b. If ROI is used as the basis for evaluation, would Megatronics Corporation likely be in favor of the acquisition of the competitor?

5. 4. Calculate the Northeast Division's ROI after acquisition of competitor but before upgrading.

6. 5-a. Assume that Megatronics uses residual income to evaluate performance and desires a 12 percent minimum return on invested capital. Compute the current residual income of the Northeast Division and the division’s residual income if the competitor is acquired.

7. 5-b. If divisional management is being evaluated on the basis of residual income, will the Northeast Division likely pursue acquisition of the competitor?

Answer 1

Return on investment, or ROI, is the most common profitability ratio. The method is to divide net profit by total invested assets/CAPITAL.

ROI in various situations given

	North east division values in $	competitor value in $ without upgrading	competitor value in $ after upgrading	Northeast division acquires competitor without upgradation	Northeast division acquires competitor with upgradation
sales	4400000	2690000	2690000	7090000(2690000+4400000)	7090000
Variable cost	3300000         (75% of 4400000)	1883000(70% of sales)	1883000	5183000(3300000+1883000)	5183000
Fixed cost	913000	755000	755000	1668000(913000+755000)	1668000
Net income	187000 (4400000-3300000-913000)	52000 (2690000-1883000-755000)	52000	239000 (187000+52000)	239000
invested capital	850000	200000	325000(125000+200000)	1050000      (850000+200000)	1900000
ROI	187000/850000)*100= 22%	52000/200000)*100= 26%	52000/3250000)*100=16%	239000/1050000=22.76%	12.58%(239000/1900000)

1. The current ROI of Northeast division is 22%.The divisions ROI if competitor is acquired 12.58% (after upgradation)

2.No. The ROI of northeast division will drop from 22% to 12.58% if it acquired competitor after upgradation.So it is not likely to acquire competitor on the basis of ROI.

3a.ROI of competitor as it is 26% and after upgradation is 16%

3b.Megatronics ROI has been 15% as a whole. whereas the competitor stand alone ROI after upgradation is 16%. Megatronics will more likely be in favor of acquiring competitor,

4.Northeast division ROI after acquiring competitor before upgrading is 22.76%