Question

Minh Phuong, head of the HCMC Division of Thanh Long Corporation, has just completed a miserable nine months. “If it could have gone wrong, it did. Sales are down, profit is down, inventories are bloated, and quite frankly, I’m beginning to worry about my job”, she moaned. Phuong is evaluated on the basis of return on investment (ROI). Selected figures for the past nine months following:

Sales……………………………. $14,400,000

Profit……………… 1,080,000

Average operating assets…….. 18,000,000

In an effort to make something out of nothing and to salvage the current year’s performance, Phuong was contemplating implementation of some of all of the following four strategies:

1. Write off and discard $180,000 of obsolete inventory. The company will take a loss on disposal.

2. Accelerate the collection of $240,000 of overdue customer account receivable.

3. Stop advertising through year-end and drastically reduce outlays for repairs and maintenance. These actions are expected to save the division $450,000 of expenses and will conserve cash resources.

4. Acquire two competitors that are expected to have the following financial characteristics:

Projected sales Projected operating expenses Projected average operating assets

Tetra Holdings………… $9,000,000 $7,200,000 $15,000,000

Thanh Long Corporation…… 13,500,000 12,360,000    14,250,000

Required: - 1. Compute sales margin, asset turnover, and ROI for the HCMC Division of Thanh Long Corporation for the past nine months.

- 2. Evaluate each of the first two strategies listed, with respect to its effect on the HCMC Division’s last nine months’ performance, and make recommendation to Phuong regarding which, if any, to adopt.

- 3. Are there possible long-term problems associated with strategy 3? Briefly explain.

- 4. Determine the ROI of investment in Tetra Holdings and do the same for the investment in Thanh Long Corporation. Should Phuong reject both acquisitions, acquire one company, or acquire both companies? Assume that sufficient capital is available to fund investments in both competitors.

Answer 1

(1)

Sales	14400000
Profit	1080000
Avg. Operating assets	18000000
Sales Margin	=profit/sales
	=1080000/14400000
	7.50%
Asset Turnover	=sales/avg. assets
	=14400000/18000000
	0.80	Times
ROI	=Profit/Avg. assets
	=1080000/18000000
	6.00%

(2)

	Original	Strategy 1	Strategy 2
Sales	14400000	14400000	14400000
Profit	1080000	900000	1080000
		(14400000-180000)
Avg. Operating assets	18000000	17910000	17880000
		(18000000-(180000/2))	(18000000-(240000/2))
Sales Margin
=profit/sales	=1080000/14400000	=900000/14400000	=1080000/14400000
	7.50%	6.25%	7.50%
Asset Turnover
=sales/avg. assets	=14400000/18000000	=14400000/17820000	=14400000/17880000
	0.80	0.80	0.81
ROI
=Profit/Avg. assets	=1080000/18000000	=900000/17820000	=1080000/17880000
	6.00%	5.03%	6.04%
Thus, Phuong is recommended Strategy-2 as it improves ROI on the basis of which she is evaluated.

(3)

Yes, there are long term problems associated with Strategy-3 which are:

• Advertisement cannot be stopped for long time as it can effect sales and reduce revenue.
• Repairs and maintenance expense is also not possible to reduce for long time. If no repairs are done, equipments will not function properly and it will impact production.

Thus, Eliminating or reducing Advertisement or Repairs and maintenance expense can increase profit for short time, but it is not possible for long time.

(4)

	Tetra Holdings	Thanh Long Corporation
Projected sales	90,00,000	1,35,00,000
-Projected operating expenses	-72,00,000	-1,23,60,000
Projected Profit	18,00,000	11,40,000
Projected average operating assets	1,50,00,000	1,42,50,000
ROI
=Profit/Avg. assets	12.00%	8.00%

	Reject Both	Acquire Tetra	Acquire Thanh Long	Acquire Both
Profit	1080000	28,80,000	22,20,000	40,20,000
Average Assets	18000000	3,30,00,000	3,22,50,000	4,72,50,000
ROI	6.00%	8.73%	6.88%	8.51%
Thus, Phuong is recommended to acquire Tetra Holdings as it gives highest ROI.