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 14 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		$	4,250,000				$	2,650,000
Variable costs			70	% of sales				60	% of sales
Fixed costs		$	1,095,000				$	972,000
Invested capital		$	1,000,000				$	400,000

Management has determined that in order to upgrade the competitor to Megatronics’ standards, an additional $150,000 of invested capital would be needed.

Required:

1. Compute the current ROI of the Northeast Division and the division’s ROI if the competitor is acquired.

2. If divisional management is being evaluated on the basis of ROI, will the Northeast Division likely pursue acquisition of the competitor?

3-a. Compute the ROI of the competitor as it is now and after the intended upgrade.

3-b. If ROI is used as the basis for evaluation, would Megatronics Corporation likely be in favor of the acquisition of the competitor?

4. Calculate the Northeast Division's ROI after acquisition of competitor but before upgrading.

5-a. Assume that Megatronics uses residual income to evaluate performance and desires a 10 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.

5-b. If divisional management is being evaluated on the basis of residual income, will the Northeast Division likely pursue acquisition of the competitor?

Compute the current ROI of the Northeast Division and the division’s ROI if the competitor is acquired. (Round your answers to 2 decimal places (i.e., .1234 should be entered as 12.34).)

	Current ROI 18.00 % ROI if competitor is acquired %

Compute the ROI of the competitor as it is now and after the intended upgrade.

	ROI before upgrading % ROI after upgrading %

Assume that Megatronics uses residual income to evaluate performance and desires a 10 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.

	Current residual income Residual income if competitor is acquired

Answer 1

Formula used for calculation
ROI =	Operating Income/Invested capital%
Residual Income =
	Operating Income-10% of invested capital
Requirement 1
Current ROI
		Northeast Division
	Sales	4250000
	Variable cost	2975000
	Fixed cost	1095000
	Operating Income	180000
	Invested capital	1000000
Current ROI		18
Divison's ROI if competitor is acquired
		Northeast Division	Competitor	Total
	Sales	4250000	2650000	6900000
	Variable cost	2975000	1590000	4565000
	Fixed cost	1095000	972000	2067000
	Operating Income	180000	88000	268000
	Invested capital	1000000	550000	1550000
Division ROI if competitor is acquired				17.29032
Requirement 2
Yes
If divisional management is being evaluated on the basis of ROI, Northeast Division is
likely to persue the acqisition of competitor
Requirement 3a)
Competitor's ROI as it is now
	Sales		2650000
	Variable cost		1590000
	Fixed cost		972000
	Operating Income		88000
	Invested capital		400000
Competitor's ROI as it is now			22
Competitor's ROI after upgradation
	Sales		2650000
	Variable cost		1590000
	Fixed cost		972000
	Operating Income		88000
	Invested capital		550000
			16
Requirement 3b)
Yes, Megtronics Corporation is most likely to be in favour of acquisition as Competitor's
ROI after and before upgradation is more than company's overall ROI
Requirement 4
Northeast's Division's ROI after acquistion of competitor but before upgrading
		Northeast Division	Competitor	Total
	Sales	4250000	2650000	6900000
	Variable cost	2975000	1590000	4565000
	Fixed cost	1095000	972000	2067000
	Operating Income	180000	88000	268000
	Invested capital	1000000	400000	1400000
Northeast's Division's ROI after acquistion of competitor but before upgrading				19.14286
Requirement 5a)
Computation of current residual Income of northeast division
		Northeast Division
	Sales	4250000
	Variable cost	2975000
	Fixed cost	1095000
	Operating Income	180000
	Minimum return required	100000
	Invested capital	1000000
	Residual Income	80000
Computation of residual Income of northeast division if competitor is acquired
		Northeast Division	Competitor	Total
	Sales	4250000	2650000	6900000
	Variable cost	2975000	1590000	4565000
	Fixed cost	1095000	972000	2067000
	Operating Income	180000	88000	268000
	Invested capital	1000000	550000	1550000
	Minimum return required			155000
	Residual Income			113000
Yes, Northeast division is most likely to acquire the competitor as its residual income
after acquisition of competitor is more than before acquistion of competitor