Question 4 (15 marks)

Pacific Limited is a retailer of commercial gadgets. At the end of each year, the divisional managers are evaluated for the performances of their divisions and bonuses are awarded according to their achievement based on the ROI. Last year, the company as a whole produced an ROI of 14 per cent.

During the past week, the management of the companys Deluxe Division was contacted about the possibility of buying the operations of a competitor, SuperPart, which wished to cease its retail operations. The following data relate to recent performance of both the Deluxe Division and SuperPart.

	Deluxe Division	SuperPart
Sales	$840,000	$520,000
Variable costs	70% of sales	65% of sales
Fixed costs	$215,000	$167,000
Invested capital	$185,000	$62,500

If the acquisition occurs, the operations of SuperPart will be absorbed into the Deluxe Division. The operations of Superpart will need to be upgraded to meet the high standards of Pacific Limited which would require an additional $37,500 of invested capital.

Required:

1. Calculate the current ROI of the Deluxe Division and the ROI of the combined Deluxe Division if SuperPart is acquired.

(6 marks)

2. Discuss the likely reaction of divisional management towards the acquisition.

(2 marks)

3. Predict and explain the likely reaction of Pacific Limiteds corporate management to the acquisition.

(2 marks)

4. Assume that Pacific Limited uses residual income to evaluate performance and desires a 12 per cent minimum return on invested capital. Calculate the current residual income of the Deluxe Division and the combined Divisions residual income if Superpart is acquired. Evaluate the divisional management reaction towards the acquisition.

(5 marks)