Question

Megatronics Corporation, a massive retailer of electronic products, is organized in four separate divi-sions. 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 13 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 CompetitorSales ............................................................................................................ $8,400,000 $5,200,000Variable costs ................................................................................................ 70% of sales 65% of salesFixed costs .................................................................................................... $2,150,000 $1,670,000Invested capital ............................................................................................. $1,850,000 $625,000 Management has determined that in order to upgrade the competitor to Megatronics’ standards, an addi-tional $375,000 of invested capital would be needed. ■ Problem 13–38 Improving ROI (LO 3) 2. ROI: 25%■ Problem 13–39 Residual Income (LO 2, 4) ■ Problem 13–40 Increasing ROI over Time; Accelerated Depreciation (LO 2, 4, 5) Year 2, ROI based on net book value: 12.5% ■ Problem 13–41 Increasing Residual Income over Time (LO 2, 4, 5) Year 1, residual income (based on net book value): $5,000 ■ Problem 13–42 ROI and Residual Income; Investment Evaluation (LO 2, 3, 4, 8)3. Income: $150,0005. Current residual income of the Northeast Division: $148,000 hiL10912_ch13_546-589.indd 5807/23/10 9:55 PM Chapter 13 Investment Centers and Transfer Pricing 581 Required: As a group, complete the following requirements. 1 . Compute the current ROI of the Northeast Division and the division’s ROI if the competitor is acquired. 2 . What is the likely reaction of divisional management toward the acquisition? Why? 3 . What is the likely reaction of Megatronics’ corporate management toward the acquisition? Why? 4 . Would the division be better off if it didn’t upgrade the competitor to Megatronics’ standards? Show computations to support your answer. 5 . 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 Divi-sion and the division’s residual income if the competitor is acquired. Will divisional management be likely to change its attitude toward the acquisition? Why?

Answer 1

Answer with Explanation:

Step 1: Compute the ROI for Northeast Division and competitor as follows :

The result of the above table is as follows :

Step 2: Likely reaction of divisional management toward the acquisition

The overall return on investment appears to decrease by roughly ~ 2% as a result of acquisition of the compeititor. The divisional management would not be positive towards acquiring the compeititor.

Step 3: ROI with and without upgrade as follows :

The result of the above table is as follows :

Step 4: Likely reaction of corporate management toward the acquistion :

Corporate management would likely favor the acquisition.The earnings of Megatronics has been around 20% return, and the competitor’s ROI of 24% will improve the numbers of organization. Even if the $3,75,000 upgrade is made, the competitor’s ROI would be 15% if past earnings trends continue .

Step 5: Compare the ROI of Northeast Division vs Competitor (without upgrade) acquired

Step 6: Compare the divisional profit of Northeast Division vs Northeast Division (with acquisition)

Step 7: Yes, management most likely will change its attitude. Residual income will increase by $ 5,50,000 as a result of the acquisition.