You have been provided with the below-selected data from World Corporation, a company with several divisions. Division managers are evaluated at year-end, and bonuses are awarded based on ROI. Last year, World Corporation as a whole, produced a 14 percent return on its investment (ROI).

Just recently, the management of World’s Eastern Division was approached about the possibility of acquiring a competitor. If the competitor is acquired, the investment required would be the competitor’s net operating assets. The data that follow relate to the recent performance of World’s Eastern Division and the competitor company:

	Eastern Division	Competitor Company
Sales	$4,200,000	$2,600,000
Variable Costs	70% of sales	65% of sales
Fixed Costs	$1,075,000	$900,000
Net Operating Assets	$925,000	$100,000

Eastern Division management has determined that merging the competitor company with World’s operating systems would require an additional $187,500 investment in operating assets, that is, an additional $187,500 in invested capital would be needed.

Required: Show all calculations

1. Compute the current ROI of the Eastern Division.

2. What would Eastern Division’s ROI be if the competitor company was acquired?

3. What is the likely reaction of Eastern Division’s management toward this acquisition and why (Be as specific as possible)?

4. What would the likely reaction of the World’s top management be toward this acquisition and why (Be as specific as possible)?

5. Suppose that World uses the residual income to evaluate performance and desires a 14 percent minimum return on invested capital. Compute the current residual income of the Eastern Division.

6. Compute Eastern Division’s residual income if the competitor company was acquired.

7. If Residual Income is used as the performance measure for divisions by World, what is the likely reaction of Eastern Division’s management toward this acquisition and why (Be as specific as possible)?

Answer rating: 100% (QA)

Answer Solution 1 ROI of eastern division Operating income operating assets 420000003 1075000925000 ... View the full answer