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 12 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		$8,600,000			$4,250,000
Variable costs		75% of sales			60% of sales
Fixed costs		$1,800,000			$1,600,000
Invested capital		$3,100,000			$225,000
Management has determined that in order to upgrade the competitor to Megatronics' standards, an
additional $275,000 of invested capital would be needed.
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 an 11 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. Will divisional management
	be likely to change its attitude toward the acquisition? Why?

Answer 1

1	ROI				(Amount($))
	Particulars		Northeast Division		Competitor
	Sales		8600000		4250000
	Variable Cost	75% of Sales	6450000	60% of Sales	2550000
	Fixed Cost		1800000		1600000
	Net Profit		350000		100000
	Invested Capital		3100000		225000
	ROI	(NP/IC*100)	11%		44%
2	Divisional management may not accept acqusition since new business will chage management intention about theit work till now
3	Megatronics' corporate management may accept acquisition since return on investment is high.
4
	Return on Income	=	Net profit/Invested Capital*100
	Particulars		Northeast Division		Competitor
	Sales		8600000		4250000
	Variable Cost	75% of Sales	6450000	60% of Sales	2550000
	Fixed Cost		1800000		1600000
	Net Profit		350000		100000
	Invested Capital		3100000		500000
	ROI		11%		20%
	Even after upgrating competitor with additonal capital it is better to acquire.
5
	Residual Income	=	Net Operating Income-(operating Assets*required return on assets)
	Particulars		Northeast Division		Division RI after acqusition
	Sales		8600000		12850000
	Variable Cost	75% of Sales	6450000		9637500
	Fixed Cost		1800000		1800000
	Net Profit		350000		1412500
	Invested Capital		3100000		500000
	Required ROI		11%		11%
	Residual Income		0		1357500
	Divisional management change their decision regarding acqusition based on residual value.
	Note: it is assumed that fixed cost is same even increasing the output.