Question

Premier Brands buys and manages consumer personal products brands such as cosmetics, hair care, and personal hygiene. Premier management purchases underperforming brands and redesigns their marketing strategy and brand equity positioning, and then promotes the repositioned brand to the mega– retail chains (Walmart and Kmart). Each product line manager is evaluated and rewarded based on return on net assets (RONA). RONA is calculated as net income divided by net assets where net assets is total assets invested in the product line less current liabilities in the product line [ RONA Net income / ( Total assets Current liabilities)]. For every 1 percent of RONA (or fraction thereof) in excess of 12 percent of the product line returns, the product line manager receives a bonus of $ 250,000. So, if a manager’s RONA is 13.68 percent, his or her bonus is $ 420,000 [(13.68% 12.00%) 100 $ 250,000]. Premier’s weighted average cost of capital (WACC) is 12.43 percent.
Amy Guttman, one of Premier’s three product line managers, manages a portfolio of four brands in the hair care business. These four brands currently generate net income of $ 708,000, requiring $ 6.5 million of total assets and $ 1.3 million of current liabilities. Guttman is evaluating two possible brand acquisitions: Brand 1 and Brand 2. The following table summarizes the salient information about each brand (thousands).



Required:
a. Given Premier’s incentive plan, will Amy Guttman acquire Brand 1 and/ or Brand 2, or neither? Justify your answer with supporting calculations.
b. Suppose that Premier’s WACC is 15.22 percent instead of 12.43 percent, and the bonus system remains as described in the problem. How do Amy’s decisions in part (a) change? Explain your answer.
c. Given the facts as stated in the problem, if you were the sole owner of Premier Products, would you acquire Brand 1 and/ or Brand 2, or neither? Justify your answer with supporting calculations.
d. Given the facts as stated in the problem except that Premier’s WACC is 15.22 percent instead of 12.43 percent, if you were the sole owner of Premier Products, would you acquire Brand 1 and/ or Brand 2, or neither? Justify your answer with supporting calculations.
e. Why do some companies use RONA instead of ROA (net income/ total assets)? In other words, describe how the incentives generated by using RONA differ from the incentives from usingROA.


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  • CreatedDecember 15, 2014
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