Reference no: EM133185736

Question - The board of BMC has advised the manager of the Clothing Retail Division to consider acquiring a competitor located in Sydney for improving the conglomerate's clothing retail market share. BMC has always used return on investment (ROI) for evaluating the performance of its divisions; the manager of any division that reports an annual increase in their ROI is given a bonus, but the managers of divisions where the ROI declines must provide a very convincing explanation as to why they should get a bonus. Where ROI has declined, the bonus is limited to only 50 per cent of the bonus that is paid to the divisions that report an increase in ROI.

Some managers are petitioning the board of BMC for changing the divisions' performance evaluation from ROI to a residual income (RI), using the conglomerate's required annual rate of return of 15 percent.

The following data relate to the most recent financial year:

Table 1 - Financial data Clothing Retail Division	Competitor
Total assets	$12,000,000
Sales revenue	$15,000,000
Less
Variable expense	$8,000,000
Fixed expense	$3,000,000
Operating profit	$4,000,000

Required -

a) Calculate the ROI for the Clothing Retail Division and the competitor before the acquisition; calculate the ROI for the entire division after merger and acquisition (i.e., combing the Clothing Retail Division with the competitor). Explain why the manager of the Clothing Retail Division may be reluctant to acquire the competitor. Provide calculations based on the compensation plan discussed above.

b) If division managers were evaluated based on divisional RI, would the manager of the Clothing Retail Division be more motivated to acquire the competitor? Provide calculations to support your answer.