Veg Ltd has recently purchased two processing plants in Hawkes Bay area. The CEO has compared the
Question:
Veg Ltd has recently purchased two processing plants in Hawke’s Bay area. The CEO has compared the two divisions' profits and has indicated that the Hastings plant is performing much better than the Napier plant. The plant managers receive a bonus if their plants’ return exceeds Veg Ltd’s required 10% return on investment.
You have explained to the CEO that comparing the profit figures of the two divisions will not provide a good performance comparison due to the different scales of the two divisions. He has asked you to provide a better alternative and supplies you with the following information.
Napier | Hastings | |
Sales | $250,000 | $200,000 |
Operating Income | $78,000 | $342,000 |
Assets 1/1/2021 | $550,000 | $2,700,000 |
Assets 31/12/2021 | $750,000 | $4,500,000 |
Tasks
(a) Calculate the ROI (Return on Investment) of the two divisions as at 31 December 2021. Show each division’s profit margin and asset turnover.
(b) As a way of improving profit levels, the CEO is encouraging the plant managers to invest in new equipment to process a new type of vegetable crop. The Napier manager has indicated she believes the new equipment is not a good investment and has strongly resisted the investment. In contrast the Hastings plant manager is very keen to adopt the new investment.
Details of the investment are:
Vegetable Equipment | |
Increase in Operating Income by: | $44,000 |
Increase in average assets invested by: | $400,000 |
With reference to each division’s ROI, briefly explain why the Napier plant manager believes the new equipment is not a good investment and why the Hastings manager believes it is.
(c) Comment on the use of ROI to evaluate the performance of investment centers.
Expert Answer:
a Napier Hastings Return on investment ROI 1200 950 Profit margin 3120 17100 Asset turnover 038 006 ... View the full answer
