performance analysis

Profitability
At first sight it appears that Victular would see a much greater return on its investment if it acquired Merlot
rather than Grappa. A closer analysis of the figures suggests that this may not be the case.
Merlot has an ROCE over 40% higher than Grappa’s and an ROE more than double Grappa’s ROE. However,
the difference is due more to the lower level of equity in Merlot than to the superiority of its profit. Merlot’s
equity (2,800) is only half that of Grappa (5,500). This reduces the denominator for ROCE and doubles the
ROE.

Merlot ROCE = 1,990 / (2,800 +6,700) = 20.9%
Grappa ROCE = 1,260 / (5,500 + 3,000 ) = 14.8%
Difference of S.H.E = 5,500(Grappa) – 2,800 (Merlot)= 2,700, (almost double of Merlot)
but total difference in capital employed which is S.H.E + non-current liabilities= 1,000 only.
Merlot capital employed = (2,800 + 6,700) = 9,500
Grappa capital employed = (5,500 + 3,000) = 8,500
so the increase in S.H.E in Grappa is not the main cause for its ROCE to decline, because the increase in S.H.E is balanced with the decrease in long term liabilities, so total denominator of Grappa is not higher than Merlot’s.,