P1338 LO13.1 13.2 13.3 13.4 13.11 ROI versus residual income; intentives: bonus schemes: manufacturer Fun Time Company (FTC). a subsidiary of New Age Ind ustrles. manufactures gocarts. water skis and motorised scooters. With the increasing popularity of electronic arcade games, New Age has been encouraging FTC to diversify into some of these other recreational areas. Arcade Unlimited Ltd (AUL) is a large manufacturer of arcade games and it is looking for a friendly buyer. New Age's top management believes that AUL's assets could be acquired for an investment of only $4.8 million and has strongly urged Will Kelly. the divisional manager of FTC. to consider acquiring AUL. Kelly has reviewed the financial statements of AUL and he believes that the acquisition may not be in the best interests of FTC. However, he knows that if he does not acquire AUL, New Age's management is not going to be pleased! Kelly exciaims to his divisional management team: 'if only we could convince them to base our bonuses on something other than ROI, this acquisition would look more attractive. If only our bonuses were based on residual income. using the company's weighted average cost of capital of 15 per cent'. New Age has always evaluated the divisions on the basis of ROI, and the target ROI for each division is 20 per cent. The management team of any division that reports an annual Increase in their ROI ls 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. The following data relate to the most recent nancial year: The following data relate to the most recent financial year: AUL FTC Sales revenue $4 650000 $14 250 um less Variable expenses 1 950 000 9 00) (I'll) Fixed expenses 1 800 000 2 250 0(1) Operating prot 5 900000 $ 3000000 Currentasacts 52 850000 3 34500\") Longtent: assets 1 650 000 8 550 000 Total assets 91500000 $120000\") Current liabilities $1 275 000 3 2 III) 0E!) Long[em liability 1 8-00 000 5 Til) 0t!) Shareholders' equity 1 425 000 4 200 041) Total liabilitiesandequityr 34500000 $120m0) Required: 1. Explain why FTC may be reluctant to acquire AUL. Provide calculations. 2. If New Age were to use residual income to measure divisional performance and evaluate managers. would FTC be more motivated to acquire AUL? Provide calculations. 3. Comment on the current bonus scheme and outline two other schemes that New Age could use to deliver bonuses to divisional managers