Fun Time Sports (FTS) is a subsidiary of New Age Industries. Fun Time Sports manufactures go-carts, water skis and motorized scooters. With the increasing popularity of electronic arcade games, New Age industries have been encouraging FTS to diversify into some of these other recreational areas. Arcade Unlimited is a large manufacturer of arcade games and is looking for a friendly buyer. New Age's top management believes that AUL's assets could be acquired for an investment of only $1.6 million and has strongly urged Mr. Belly Tycoon, the divisional manager of FTS, to consider acquiring AUL.

Belly has reviewed the financial statements of AUL and he believes that the acquisition may not be in the best interests of FTS. However, he knows that if he does not acquire AUL, New Age management is not going to be at all pleased! Belly exclaims to his divisional management team: 'If only we could convince them to base our bonuses on something other than ROI'. New Age has always evaluated the divisions on the basis of ROI, and the target ROI for each division is 20%. 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 data relates to the most recent financial year:

Fun Time Sports Arcade Unlimited

Sales $4 750 000 $1 550 000

Less:Variable expenses 3 000 000 650 000

Fixed expenses 750 000 600 000

Operating profit $1 000 000 $ 300 000

Current assets 1 150 000 950 000

Long-term assets 2 850 000 550 000

Total assets $ 4 000 000 $1 500 000

Current liabilities 700 000 425 000

Long term liability 1 900 000 600 000

Shareholders' equity 1 400 000 475 000

Total liabilities and equity $ 4 000 000 $1 500 000

Required:

(a)Explain why FTS may be reluctant to acquire AUL. Provide calculations to show basis for your answer.

(b)If New Age were to use residual income to measure divisional performance and evaluate managers, would FTS be more likely to acquire AUL? Provide calculations. Assume imputed interest charge of 15%.

(c)Comment on the current bonus scheme and outline two other schemes that New Age could sue to deliver bonuses to divisional managers.