Woolworths Holdings Limited (WW), a South African company based in Cape Town, operates multiple divisions world-wide. It is the company's policy to treat each division as an investment centre for the purposes of divisional performance measurement. As such, WW gives its divisions significant autonomy in their investment decisions.

The divisions are as follows:

1. The Food Division

Senior management of WW is planning to launch a new energy bar division that will use Hero peanut butter as a basic ingredient. After in-depth market research, the following information was obtained for Hero Energy Bar (HEB) Division:

1.The initial investment will be R1,8 million and will be depreciated on a straight-line basis over four years with a Rnil residual value at the end of the fourth year. Book value of the investment is anticipated to approximate its market value.

2. The net operating profit are expected to be as follows:

Net Operating Profit

Year 1

Year 2

Year 3

Year 4

R600 000

R708 000

R877 920

R1123 738

3.Cash fixed costs (not included above) are expected to be R80 000 in year 1. The year 2 to year 4 expected annual escalation percentage is based on the following probabilities:

Annul escalation % (year 2-4)

Probability

4%

35%

5%

40%

6%

25%

Mr Mbewu will be appointed as divisional manager of the new division. He is not in favour of the new investment and his appointment.

The financial director of WW has proposed that the performance measurement for bonus purposes of the new division should be based on residual income and return on investment.

The target residual income will be R100 000 per year.

Management performance will be based on a required return on investment of 15% per year (before tax), based on opening investment balances using market values.

The corporate tax rate is 28% for all periods under consideration.

Divisional managers do not have control over tax structures and tax will therefore be excluded from their performance measures.

1. Aya Division

Aya is based in eSwatini and purchases all its input-parts from Yena (a company based in eSwatini ). Aya reported an annual profit before tax of SZL 18,1 million for the 2021 financial year. This was after deducting annual interest expense of SZL 2,1 million and an expensed amount of SZL 3 million for the full cost of development and launch of a new product.

The development and launch expenditure are expected to generate profit for the current and the next two years.

The development and launch costs did not meet the recognition criteria in terms of IAS38 (intangible asset standard), the tax authorities were in line with accounting in terms of allowances (i.e., wear & tear approximates depreciation).

Below is an extract of the Statement of Financial Position for the year 2021:

Non-current assets (book-value)

SZL 60 million

Non-current liabilities (Swazi Gov loan)

SZL 26 million

Net working capital (Dt balance)

SZL 24 million

The replacement cost of the non-current assets has been estimated at SZL 74 million.

The Swaziland government has created a funding house to incentivise businesses setting up in their country, charging rates that are significantly lower to market (currently at the nominal interest of 7,75% p.a.).

Aya has a cost of equity of 12.52% p.a. and the calculated risk adjusted weighted average cost of capital was 11,5% per annum.

Aya has a corporate tax rate of 30%.

Currency exchange

SZL1=ZAR1

1. Clothing Division:

Management of the Clothing Division has been considering the idea of implementing a bonus incentive scheme, but he is uncertain as to how to go about it. As they are unsure about which aspects to take into consideration when implementing a bonus scheme.

REQUIRED:

1. Food Division

Calculate the expected residual income and return on investment for year 1, year 2 and year 3 for HEB.

1. Aya Division

Using EVA as an evaluation method determine whether Aya's management created value in the 2021 financial year.

1. Clothing Division

Advise the manager of the Clothing Division, what the purpose of a bonus incentive scheme is.

Your advice should include the aspects that should be included in his performance appraisal and how each aspect could be measured.

1. Discussion

Discuss the advantages and disadvantages of ROI and RI. Your discussion should include which measure you would recommend for performance evaluation.