Reference no: EM133003905

The Optacomm Communications Company (OCC) has a decentralised structure. The senior managers of each Strategic Business Unit (SBU) are encouraged to make decisions and are required to account for their outcome using financial performance measures. The primary measure of performance is Return on Investment (ROI). OCC reviews performance annually and the manager's bonus is calculated on the increase of the ROI each year. OCC initially offered a mobile phone and messaging service, mostly in the major capital cities of Australia however, to become a full 'National' operator OCC has a strategic goal of expanding its network across all major regional centres. The Senior Operations Manager for Mobile Services (MOBS) has been enjoying high ROI (and bonuses) for the past few years and will now be responsible for the expanded network.

Problem a) The manager of the MOBS Division of OCC has a CURRENT forecast for SALES for the next year of $60,000,000 and a forecast PROFIT MARGIN of 11%. The current INVESTED CAPITAL for the MOBS Division is $35,000,000.

Problem b) The manager of MOBS has worked through the financial projections for the proposed expansion of the network and has estimated the following would apply if the expansion took place: Total projected sales would increase to $72,000,000, profit margin would fall to approximately 10% and the total invested capital would increase to $52,500,000.

(i) Recalculate the ROI if the expansion to the network was to go ahead with these new projections.

(ii) The manager begins to consider options for increasing the projected ROI over this period and is considering lowering the customer support (help staff) and reducing the routine maintenance costs on the existing network. Calculate the amount of COST REDUCTIONS that would be necessary to obtain a projected ROI of 16%. (Note due to competition, Sell Price can NOT be increased and the decision to invest the extra capital cannot be changed.)

(iii) What are the issues that may occur by using ROI to measure performance and describe how these issues may arise when only ROI is used to measure performance?

Problem c) OCC have been considering using Economic Value Add (EVA) as a second measure of performance, (so that a positive result would allow a bonus to be paid). Complete the following:

(i) Calculate the forecast EVA both without AND with the proposed expansion of the mobile network. Assume the same amounts of Before Tax Profit but use 30% tax rate and reduce the invested capital by $7,500,000 (in both cases) to allow for creditors and other items that do not require company funding. Also Assume OCC's Weighted Average Cost of Capital would be 9% for both scenarios.

(ii) Considering the result of c) (i), is the manager for the MOB Division more likely to support the acquisition proposal if EVA is also considered when determining the manager's bonus. Why or why not?