- 15 Marks
Question
Ngerige and Sons Limited has four operating divisions spread across four cities in Nigeria: Lagos, Kano, Gombe, and Enugu. These divisions are treated as investment centres for performance reporting purposes. The following information is available:
| Particulars | Lagos | Kano | Gombe | Enugu |
|---|---|---|---|---|
| Divisional Investment (N) | 10,000,000 | 4,000,000 | 3,000,000 | 7,000,000 |
| Divisional Sales (N) | 53,000,000 | 23,000,000 | 24,600,000 | 29,400,000 |
| Divisional Variable Costs (N) | 50,000,000 | 22,000,000 | 23,400,000 | 27,400,000 |
| Specific Fixed Costs (N) | 1,500,000 | 750,000 | 600,000 | 800,000 |
The company’s annual general fixed cost is N1,300,000, apportioned to divisions based on sales. The cost of capital for Ngerige and Sons Limited is 7.5%. Ignore taxation.
Required:
i. Evaluate the performance of the divisions using the following methods:
- ROI method. (3 Marks)
- Residual Income Method. (3 Marks)
ii. Re-evaluate the residual income situation for the company given an adjusted cost of capital of 10%. (3 Marks)
Answer
b. (i) Evaluate the performance of the divisions using ROI and residual
income method.
Returns on capital employed (ROI)
Using ROI, Enugu division is more profitable than the other three Divisions
Residual Income: At cost of capital of 7½%
Appraising the divisions using residual income method with an imputed interest of 7.50%, Enugu is more profitable.
Residual income at cost of capital of 10%
In appraising the divisions with a imputed interest of 10%, Enugu is still
profitable.
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