Question 6: (25 points) DOTS Holdings (DOTS) was founded in Hong Kong since 1980s. The company is a well- diversified conglomerate with operations of over 30 subsidiaries throughout the South East Asia region. Although DOTS has survived though a few major economic crises, the firm is under tremendous pressure to perform. In particular, the presence of online businesses and advanced digital technologies bears stiff competition and some subsidiaries may no longer have any commercial value. To ensure sustainability, DOTS management is very diligent in managing the performance of each individual subsidiary. One of DOTS subsidiaries is Sunway Fitness (Sunway), a fitness club operating in Hong Kong. Currently, Sunway has 3 different branches located in high-traffic areas. The branch manager's performance is measured using return on investment (ROI) on an annual basis. Sunway requires all assets to earn a minimum return of 12%. Selected financial information for Sunway is as follows: HKS'000 Branch TST MK CWB Fee Revenue Fixed Costs Variable Costs Current Assets Non-current Assets Current Liabilities $ $ $ $ $ $ 1,800 936 465 800 1,300 80 $ S $ $ S $ 2,100 1,092 567 900 2,775 $ 4,500 $ 2,520 S 1,500 $ 1,000 $ 2.000 s 480 240 With the goal of continuously improve Sunway's ROI, Senga Cheng, the manager of the MK branch, has proposed the following initiatives for the coming period: a. Write-off obsolete equipment amounted to HK$60,000 and recognize a loss in disposal. b. Cut $150,000 spending on marketing and postponed routine maintenance on fitness equipment. c. Speed up the collection of accounts receivable amounted to $30,000 which will overdue in 3 months. Another subsidiary is Tai Fat Auto (Tai Fat), a car dealership located in a busy commercial district since 1984. Tai Fat has 3 divisions: new cars, used cars, and service. Ten years ago, Tai Fat replaced its aging showroom and service center with a new, state-of-the-art facility - the building costs $12 million whereas the land costs $900,000. The market for new vehicles is very competitive because many buyers shop on the Internet before visiting new car dealers. Once customers decide to purchase a new car, they usually trade-in their used car to avoid the hassle of selling the car themselves, and hence these new car buyers are willing to accept lower prices from car dealers for their trade-ins. In fact, used cars have higher margins because there is less competition, as each used car differs in terms of mileage, condition, and options. However, nearly all used car sales are generated from vehicles brought in from the trade-in transactions. As an example of a typical transaction in Tai Fat: a new car was sold for $45,000 ($500 over dealer cost) and the buyer receives a trade-in allowance on his old car of $8,000 and pays the difference in cash. That used car is then sold for $10,800. The dealer makes $500 from the new car division and $2,800 on the used car division. Tai Fat also offers parts and service for the new and pre-owned cars it sells. 9 car division and $2,800 on the used car division. Tai Fat also offers parts and service for the new and pre-owned cars it sells. 9 The divisional managers are compensated based on residual income. The minimum required return for Tai Fat's assets is 16%. Selected financial information from Tai Fat are extracted as follows: New Cars Used Cars Service Net Income Land % occupied) Building (% occupied) Other assets (note 1) $600,000 50% 30% $2,500,000 $1,725,000 $1,813,000 40% 10% 10% 60% $6,700,000 $1,300,000 Notes: 1 2 Other assets relate to items such as inventories and account receivables Income is computed by revenues and expenses directly traceable to that department. Income taxes are charged entirely to DOT Holdings. Required: (a) Evaluate the performance of the three branches of Sunway Fitness based on ROI. Also, briefly explain the specific factor(s) that yields such performance. Show all supporting computations where necessary. Limit your response to 200 words. (5 points) (b) Evaluate Senga's initiatives one by one with respect to its effect on MK branch's ROI. Recommend which initiative(s) Senga should adapt for the coming period. Limit your response to 300 words. (5 points) (c) The marketing manager of Sunway said the following in a meeting "We only need to concern ourselves with the number of complaints received from clients during each period and this is the perfect performance measure for Sunway. As long as the number of complaints received from clients is not increasing over the period, Sunway's success can be assured with 100%." Comment on the above statement in no more than 150 words. (5 points) (d) Evaluate the performance of the three divisions of Tai Fat Auto using residual income. Show supporting computations where necessary. Limit your response to 120 words. (5 points) (e) Comment on Tai Fat's performance measurement system using residual income, especially on behavioral implications to divisional manager of New Car division, and to Tai Fat as a whole. Limit your response to 250 words. (5 points) 10