Reference no: EM132661570
Question - Viva International is a wholesaler of building supplies and has four divisions. Managers of the four divisions are evaluated on the basis of divisional Return on Investment (ROI). Last year, the ROI for the company as a whole was 13%.
During the Christmas break, management of the company's Spring Division was approached about the possibility of buying the wholesaling operations of a competitor, Bobs. The following data relate to recent performance of the Spring Division and Bobs:
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Spring
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Bobs
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Sales
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$4,200,000
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$2,600,000
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Variable cost
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70% of sales
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65% of sales
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|
Fixed cost
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$1,075,000
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$835,000
|
|
Invested capital
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$925,000
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$312,500
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If the acquisition occurs, the operations of Bobs will be absorbed into the Spring Division. The operations of Bobs will need to be upgraded to meet the high standards of Viva International, which would require an additional $187,500 of invested capital.
Required -
a) Calculate the current ROI of Spring Division and the ROI of the division if Bobs is acquired.
b) Assume that Viva International uses residual income to evaluate performance and desires a minimum required rate of return of 12% on invested capital. Calculate current residual income of Spring Division and the residual income of the division if Bobs is acquired.
c) Will Spring Division's management be likely to change its attitude towards the acquisition if Viva International uses residual income instead of ROI in performance evaluation? Why?