MA – L2 – Q1 – Divisional Performance (ROI, RI, Economic Value Added)

Calculate and compare ROI, RI, and EVA for three territories; compute required changes for central territory to achieve 20% ROI.

Question

The Aliso Group (Aliso) operates a chain of hospitality units in the country grouped into Southern, Central and Northern territories. Operations in each territory offer similar services and face similar operating environments and risks. The operations of the Group are categorised into accommodation, restaurant and bar, and other services. The table below presents a summary of the financial data of Aliso for the year ended 31 December 2023.

	Southern GH¢000	Central GH¢000	Northern GH¢000	Total GH¢000
Revenue	2,340.00	2,730.00	5,850.00	10,920.00
Variable cost	(608.40)	(737.10)	(1,813.50)	(3,159.00)
Contribution	1,731.60	1,992.90	4,036.50	7,761.00
Fixed cost	(1,216.80)	(1,419.60)	(3,122.60)	(5,759.00)
Operating profit	514.80	573.30	913.90	2,002.00
Finance cost				(234.00)
Profit before tax				1,768.00
Income tax expense				388.96
Profit for the year				1,379.04

Assets:
Non-current assets	1,300.00	3,250.00	4,290.00	8,840.00
Current assets	1,040.00	1,170.00	1,300.00	3,510.00
Total assets	2,340.00	4,420.00	5,590.00	12,350.00

Equity and Liabilities:
Equity:
Share capital				3,250.00
Accumulated reserves				5,720.00
Non-current liability:
Long-term loan				2,340.00
Current liabilities	104.00	312.00	624.00	1,040.00
Total equity and liabilities				12,350.00

Relevant information:
i) The policy of Aliso is to define residual income (RI) for each territory as operating profit less the group required rate of return of 17.5% of each territory’s total assets.

ii) The long-term loan is centrally managed and not split among the territories.

iii) Income tax is charged at 22% of profits.

iv) The market value of equity capital is GH¢11,700.00 whilst the cost of equity is at 20%.

v) The book value of long-term borrowing approximates the market value.

vi) The ROI generated by the central territory is of significant concern for the managers of Aliso and they are exploring the possibility of achieving an ROI of 20% by considering available options.

Required:
As the Management Accountant of the Aliso, prepare a report to the managers of the group in relation to the following issues:
The best performing territory in terms of:

a) Return on Investment (ROI).

b) Residual Income (RI).

c) Economic Value Added (EVA) and

d) Calculate the percentage changes in revenue, total cost and net assets during the period that would be required for the central territory to achieve a target ROI of 20%.

Answer

a) Return on Investment (ROI)

$Southern territory = Central territory = Northern territory = Operating Income before interest and tax Capital Employed GH¢2,340,000-GH¢104,000 GH¢514,800 \times 100 GH¢4,420,000-GH¢312,000 GH¢573,300 \times 100 GH¢5,590,000-GH¢624,000 GH¢913,900 \times 100 \times100 = 23.02% = 13.95% = 18.40%$

Best performing territory is the southern territory with ROI of 23.02%

(b) Residual Income (RI) = Operating profit – imputed cost of capital
Southern territory = GH¢514,800 – (17.5% x 2,340,000) = GH¢105,300
Central territory = GH¢573,300 – (17.5% x 4,420,000) = (GH¢200,200)
Northern territory = GH¢913,900 – (17.5% x 5,590,000) = GH¢64,350

Best performing territory is the southern territory with RI of GH¢105,300

(c) Economic Value Added (EVA) = NOPAT – (capital employed x WACC)

$WACC = (11 , 700 + 2 , 3402 , 340 * 0.78 * 1.10) + 11 , 700 + 2 , 34011 , 700 \times 0.20$ $= 0.013 + .167 = 18%$

	Southern Territory	Central Territory	Northern Territory
Profit	514,800	573,300	913,900
Less tax	(113,260)	(126,130)	(201,060)
Cost of capital	401,540	447,170	712,840
	(402,480)	(739,440)	(893,880)
	(940)	(292,270)	(181,040)

Best performing territory is the Southern territory with EVA of (GH¢940)

d) Required Changes for Central Territory to Achieve 20% ROI
Targeted operating profit = Targeted ROI x total Assets
= 0.20 X GH¢4,420,000
= GH¢884,000

Increase in operating profit = 884,000 – 573,000 = GH¢310,700

Percentage Change in Revenue
Revenue required = \textit{targeted Operating Profit+Fixed cost}
1–variable cost ratio

= 884,000+1,149,600  
737,100  
1–2,730,000  

= 2,303,600  
0.730  

= GH¢3,156,000  
% Increase in revenue = 3,156,000 – 2,730,000 x 100 = 15.60%  
2,730,000

Percentage Change in Total Cost
Targeted Profit = Revenue – Total Cost
GH¢884,000 = 2,730,000 – Total Cost

New Total Cost = GH¢2,730,000 – GH¢884,000
GH¢ 1,646,000

Level: Level 2

Topic: Divisional Performance
Series: JULY 2025

Uploader: Samuel Duah