Question 1: Case Study (Topic 10)

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.

3

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