Electromart is a retailer of electrical products and has four divisions. At the end of each year the four divisional managers are evaluated and bonuses are awarded based on PCI. Last year, the company as a whole produced an ROI of 13 per cent.
During the past week management of the company’s Little River Division was approached about the possibility of buying the operations of a competitor. SuperEl, which wished to cease its retail operations. The following data relate to recent performance of the Little River Division and SuperEl.
If the acquisition occurs, the operations of SuperEl will be absorbed into the Little River Division. The operations of SuperEl will need to be upgraded to meet the high standards of Electromart, which would require an additional $375,000 of invested capital.
Required:
1. Calculate the current ROI of the Little Piver Division and the ROI of the division if SuperEl acquired.
2. What is the likely reaction of divisional management towards the acquisition? Why?
3. What is the likely reaction of Electromart’s corporate management to the acquisi110′
4. Would the divis0 be better off if it did not upgrade the operation of SuperEl to Electromart’s standards? Show calculations to support your answer.
5. Assume that Electromart Uses residual income to evaluate performance and desires dual a minimum required rate of return of 12 per cent on invested capital. Calculate the current residual the division and the division’s residual income if SuperEL is acquired. Will divisional management be likely to change its attitude towards the acquisition? Explain why.
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