Question

#4

REVISED PROBLEM 13-42

ACC 650 - Management Accounting

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 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:

	NE 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:

4. Would the division be better off if it didn’t upgrade the competitor to Megatronics’ standards?
Show computations to support your answer.

Answer 1

Here management of the company’s Northeast Division was approached about the possibility of buying a competitor that had decided to redirect its retail activities

The information regarding the sales and cost is given for both i.e the North east division and the competitors, the analysis of there existing ROI will be as follows:

	North East Division	Competitor	Total
Sales	$8600000	$4250000	$12,850,000
Variable Cost	$6,450,000	$2,550,000	$9,000,000
Contribution Margin	$2,150,000	$1,700,000	$3,850,000
Fixed Cost	$18,00,000	$16,00,000	$3,400,000
Net Operating Profit	$350,000	$100,000	$450,000
Invested Capital	$3,100,000	$225,000	$3,325,000

ROI = Net Operating Profit / Invested Capital ,

here for the competitor being acquired at book value, so the invested capital will be same as $225,000.

ROI for North East Division = $ 350,000 / 3,100,000 = 11.29%

ROI for Competitor Division = $ 100000 / 225000 = 44.44 %

ROI for Combined divison = $ 450000 / 3325000 = 13.53 %

Now ,Management has determined that in order to upgrade the competitor to Megatronics’ standards, an
additional $275,000 of invested capital would be needed.

If the additional capital is invested, then the Invested capital will be = $ 225,000 + $ 275,000 = $ 500,000.

Thus the ROI if the competitor is upgraded wil be = Operating Profit / invested capital = $ 100000 / 500000

ROI of Competitor in case it is upgraded = 20%.

Thus total ROI of the divison being combined with the Competitor after upgrade = Operating profit / Invested capital.

Operating profit = $ 350,000 +$ 100,000 = $ 450,000 , and revised invested value = $ 3,100,000 + $ 500,000 = $ 3,600,000.

Thus total ROI of the divison being combined with the Competitor after upgrade = $450000 / 3,600,000 = 12.50%.

Now Would the division be better off if it didn’t upgrade the competitor to Megatronics’ standards?

- Here the existing ROI of the competitor before upgrading was =44.44%, which after upgrading becomes to 20% , as calculated above, and the existing ROI of the combined divison was = 13.53 % which becomes as 12.50% after the upgrading.

Hence if the company makes decision purely based on the ROI, then the ROI is decreasing after upgrading the competitor to the Megatronics standard , it will not be a better off decision as the ROI is decreasing due to it.

However there are other non financial consideration which also needs to be analysed, not upgrading will lead to low standard product, which ultimately hamper the goodwill and value of the Megatronics in near future and may lead to disadvantages in future.