Presently there is an increasingly more companies adopting various forms of divisions and these have various effects on the company structures and the means to run the businesses.

Required:

1. Outline and briefly explain the advantages and disadvantages of these divisions to the management. (8 marks)

2. What will be the two prerequisites for successful divisions? (2 marks)

3. Bros Ltd is a split into two divisions, A and B each with their own cost and revenue streams. Each of these are managed by a divisional manager who has the power to make all relevant investment decisions. The cost of capital is 12% for both of this divisions. Historically investment decisions have been made by computing the return on investment -ROI of any opportunities and present the return on investment of each division is 16%.

A new manager was recently appointed in division A and he argued that using residual income (RI) to make investment decisions would result into better goal congruence throughout the company.

Each division is currently considering the following separate investments:

Division A Division B

Capital Required RM 82.8 million RM 40.60 million

Sales required RM 44.60 million RM 21.80 million

Net profit margin 28% 33%

The company is seeking to maximize shareholder wealth

Required:

Calculate both the return on investment and residual income of the new investment for each of the two divisions. Comment on these results, taking into considerations manager view about residual income.

(10 marks)