Question

KG is a divisionalised company, based in South Africa, where it is quoted on the stock exchange. KG manufactures and sells small electrical equipment products. South Africa is more highly developed than the neighbouring countries. KG has enjoyed a strong home market and has exported to the neighbouring countries.
KG has had a reputation for producing high quality products. Recently, it has come under increasing competitive pressure from new, privately held, companies based in the neighbouring countries.
It appears that competitors based in these neighbouring countries have been selling lower quality products than KG and have been undercutting it quite significantly in terms of price. Sales in both KG’s home and export markets have been badly affected by the actions of these competitors in the neighbouring countries.
KG has looked at a number of possible solutions to this situation and has decided to acquire a manufacturing company in one of the neighbouring countries and move all of its production there, completely closing the manufacturing division in South Africa. This would mean that KG would purchase one of the companies that has recently become a competitor. KG would maintain its present divisionalised structure within its home country South Africa and treat the acquired company as a new division.
The Board of Directors recognises the need to carefully select a suitable acquisition target company. The Board also recognises that careful consideration will need to be given to the most suitable approach to performance management once the acquisition has been made. The Board is considering an approach based on either Return On Investment (ROI) or Residual Income (RI).

REQUIRED:
(A) Advise the Board on what information would be required to assess the suitability of an acquisition target.                               
   

Answer 1

Return On Investment (ROI) is a measure use to evaluate the efficiency of number of investment .

problem with the ROI :is it don't give satisfactory defination of profit . profit has many concept such as profit before interest and tax , profir after interest and tax ,similarly the term investment also had many concepts like Gross Book Value ,Net book value.

2) while comparing different companies Roi , it is necessary that company use similar policy method in stock valuation , valuation of fixed assets

3)Roi may influence board of director to select only Investment with high ROI ,IT MAY BE possible that investment which would reduce the company ROI but could increase the value of business .

Residual income MEANS is an excess that investment earned relative to oppurnity cost .

problem with ROI : it does not faciliates comparision between division since is driven by size of division and their investment

ADVISE: as the deal is proposed board or special commitee should assess the assumption & synergies are revenue and cost assumtions is reasonable

1) The investment is asking price is reasonable,Should be assess

2)The debt load is also a important factor. a company with a reasonable debt but with a high interest is likely be selected for acquisition.

3) As in the present example with excessive competation pressure board should look more with more top line and bottom line growth to increase long term shareholder wealth, and  kG pursuing growth through acquisition strategy should articulate the strategic under pinnings of the growth strategy & should link with overall company strategy

4) Acquisition is not a regular process ,it is very complex & risky process , board needs to take periodic updates at various stages with due diligence .

5) Director must be careful in situation where manager is emotionally invested to apoint where the objectivity is lost of acquisition

6) Before approving the plan the director must review manager integration plan

In summary effective oversight of director acquisition can create competitative advantage and enterprise value through consummation of successful deal . like wise effective oversight of director can also help avert loss..