Chapter 17: Divisional performance measurement

(a) First investment. Kestrel plc has divisions in several countries. The Accra division is currently making a profit of $82,000 p.a. on investment of $500,000. Kestrel has a target return of 15%. The manager of Accra is considering a new investment which will require additional investment of $100,000 and will generate additional profit of $17,000 p.a.

(i) Calculate whether or not the new investment is attractive to the company as a whole. (ii) Calculate the ROI of the division, with and without the new investment, and hence determine whether or not the manager would decide to accept the new investment.

(b) Alternative investment. The circumstances are the same as in (a), except that this time the manager is considering an investment that has a cost of $100,000 and will give additional profit of $16,000 p.a. Answer the same two questions.

(c) Residual income assessment. Reassess both investments, but in each case assume that the manager is assessed on his Residual Income, and that therefore it is this that determines how he makes decisions.

ROI = controllable division profit / divisional investment, using the opening investment. RI = profit less notional interest at the target return on the investment.