Question

SKE company is organized into two major divisions: Shenzhen and Shanghai. The two division managers’ annual bonuses are based on division ROI (defined as operating income divided by total assets). If a division reports an increase in ROI from the previous year, its management is automatically eligible for a bonus; however, the management of a division reporting a decline in ROI has to present an explanation to the SKE Group board and is unlikely to get any bonus. The sales of the Shenzhen division in 2019 were 5,000,000, variable cost were $2,500,000 and fixed costs were $1,800,000. Operating assets for the division at the end of 2019 were $3,600,000.

Mr. Alan Wong, the manager of the Shenzhen division, is considering a proposal to invest $600,000 in a new computerized production system. It is estimated that the new system will increase 2020 division sales of $1,600,000 and will incur fixed expenses of $600,000 annually. Variable costs of the new system will average 60% of the selling price. The company’s required rate of return is 5%.

Required:

1. Assess the attractiveness, with supporting calculations, of the proposed investment to the Shenzhen division from the perspectives of Alan Wong based on the existing performance evaluation systems. .

    

2. Recommend, with supporting calculations, any essential changes (both financial and on- financial) required to improve the performance evaluation system of the company.

    

Answer 1