A Co., B Co. & C Co. are a subsidiary of ABC group. B Co is looking for a friendly buyer for its ground sports equipment. ABC Group's CEO believes that B Co's assets could be acquired for an investment of $1.1 million and has asked Mr. Viliame, the Accountant of A Co. to consider acquiring B Co.

Mr. Viliame quickly reviewed the financial statements of B Co, and he believes that the

acquisition may not be in the best interests of ABC Group. Further, he knows that if he does not proceed with acquiring B Co, management is not going to be at all pleased! Mr. Viliame exclaims to his divisional management team: 'If only we could convince them to base our bonuses on something other than ROI'.

For the past few years, ABC Group has always evaluated the divisions on the basis of ROI, and the target ROI for each division is 22%. The management team 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% of the bonus that is paid to the divisions that report an increase in ROI.

The following represents the performance results of A Co. & B Co.

A Co. B Co.

Sales $2 375 000 $775 000

Less:

Variable expenses 1 500 000 325 000

Fixed expenses 375 000 300 000

Operating profit $500 000 $ 150 000

Current assets 575 000 475 000

Long-term assets 1 425 000 275 000

Total assets $ 2 000 000 $750 000

Current liabilities 350 000 212 500

Long term liability 950 000 300 000

Shareholders' equity 700 000 237 500

Total liabilities and equity $ 2 000 000 $750 000

Assume imputed interest charge of 12%.

Required:

a) Explain why Mr. Viliame may be reluctant to acquire B Co.. Show calculations to support your explanation. (7 marks)

b) What would you recommend to the CEO of ABC Group in terms of measuring and evaluating divisional and manager's performance, so that A Co. agrees to acquire B Co. Provide justification/calculations to support your recommendation. (7 marks)

c) Discuss the common issues that may arise between the divisional managers, when performance is measured using ROI. (6 marks)