Question

Question 4

Ghana Post Company Ltd has two divisions, EMS and the Postal division. Ghana Post Company Ltd intends to increase its investment in EMS and Postal division by GHS10,000 each. The increase in investment is expected to increase net income by GHS18,000 and GHS20,000 in EMS and Postal respectively. Currently, the assets structure of both EMS and Postal is analysed below:

                                              EMS                         Postal

                                             GHS                          GHS

                                    Investment

Motor vehicles                            70,000                     180,000

Buildings                                         30,000                     120,000

Scales/Equipment                         20,000                     100,000

                                                         120,000                     400,000

                                    Current Asset

                                     Stamps                            25,000                          50,000

                                     Stationary                       45,000                         80,000

                                      Debtors                           80,000                          70,000

                                      Bank                                                                     130,000

       60,000                         330,000

                                     Current liabilities         210,000

Creditors                         10,000    200,000     20,000        310,000

                                                            320,000                          710,000

Current Revenue for both EMS and Postal are GHS364,000 and GHS692,000 respectively. Total expenses as a percentage of revenue are 80.2% and 88.2% for EMS and Postal respectively. Assume cost of Ghana Post is 15% and the company evaluates its managers based on return on investment (ROI) and Residual Income (RI).

Required:

1. Calculate ROI before and after the expansion.
2. Using the cost of capital, determine the residual income before and after the expansion.
3. Should management of Ghana Post invest in the expansion? Give reasons

1. Describe the main characteristics and objective of profit and investment centres.
2. Explain conditions necessary for the successful introduction of both profit and investment centres.

Answer 1

	EMS, GHS	Postal, GHS
Motor vehicles	70000	180000
Buildings	30000	120000
Scales/equipment	20000	100000
Total	120000	400000
Current assets
Stamps	25000	50000
Stationary	45000	80000
Debtors	80000	70000
Bank	60000	130000
Total	210000	330000
Current liabilities
Creditors	10000	20000
Net Current assets	200000	310000
Total assets	320000	710000
Current revenue	364000	692000
Expenses %	80.20%	88.20%
Expenses $	291928	610344
Net income(Revenue-Expense)	72072	81656
Before expansion
I ROI=Net Income/Dividional Total assets	72072/320000=	81656/710000=
	22.52%	11.50%
After expansion
Increase in net income	18000	20000
New N/I(72072+18000)	90072	101656
New investment(Total assets+10000)	330000	720000
ROI=Net Income/Dividional Total assets	90072/330000=	101656/720000=
	27.29%	14.12%

ii. Residual income before & after expansion
Before expansion
Net Income	72072	81656
Capital charge	320000*15%=	710000*15%=
	48000	106500
Residual Income(N/I-Cap. Chg.)	24072	-24844
After expansion
Net Income	90072	101656
Capital charge	330000*15%=	720000*15%=
	49500	108000
Residual Income(N/I-Cap. Chg.)	40572	-6344

iii. YES.

Both ROI & Residual Income increase for both the divsisions after expansion

i. Main characteristics and objective of profit and investment centres.

Revenues & costs can be identified & collected for profit centers , with a view to assess performance of the department & its managers.

The managers here, have lesser authority than their counterparts in investment center.

whereas

Investment centers take decisions regarding capital investments, based on profitability, as above---by the divisional managers themselves.

Normally a profit center will find favor with the management , also to be an investment center.

ii. Conditions necessary for the successful introduction of both profit and investment centres.

Profit Centers

1.Division should be capable of generating revenues & collecting costs & therby assess profitability /performance.

2. Divisional managers should   be able to interact with the top management , regarding poilcy decisions such as expansions/acquisition/disposal of assets.

3. Also they should be able to give proper & timely inputs as to the successful operation (discontinuation , if needed), to the top management.

Investment Centers

1. Should be manned by people who are capable of taking independent decisions regarding CAPEX matters. 2. As these mangers are given more authority to make deciisons, they should be selected with due care .