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- 8 Marks
Question
b) Peah is a divisional manager of Monrovia Ltd. He is paid a bonus of 5% on the division’s residual income after charging the bonus. The division is currently considering an additional investment of GH¢200,000 with 10 years useful life but nil residual value. The investment is expected to yield a profit after depreciation of GH¢51,600. This will augment the existing capital employed of GH¢1,050,000 that currently offers GH¢264,400 profit after depreciation annually. The company’s policy is to accept investment projects that provide a return of at least 22%.
Required: i) Calculate the Return on Investment and Residual Incomes of the division before considering the new investment. (2 ½ marks)
ii) Advise the division on whether the new investment should be taken or not. (2 ½ marks)
iii) What will be the percentage change in the bonus of Peah if the new investment is added to the division’s existing operations? (3 marks)
Answer
i) Determination of divisional ROI and RI
Calculation of divisional ROI
Before the new investment:
Divisional Profit: GH¢264,400
Divisional Investment: GH¢1,050,000
Divisional ROI: 25.18%
After the new investment:
Divisional Profit: GH¢316,000
Divisional Investment: GH¢1,250,000
Divisional ROI: 25.28%
Calculation of divisional RI
Before the new investment:
Divisional Profit: GH¢264,400
Less imputed interest (22% x GH¢1,050,000): GH¢231,000
Residual Income: GH¢33,400
After the new investment:
Divisional Profit: GH¢316,000
Less imputed interest (22% x GH¢1,250,000): GH¢275,000
Residual Income: GH¢41,000
ii) Advice on the new investment:
Based on the ROI, the new investment is marginally beneficial in the short term as it slightly increases ROI to 25.28%. Based on the RI, it is beneficial as it increases residual income to GH¢41,000. Thus, the new investment should be accepted.
iii) Determination of bonus to the divisional manager:
5% bonus on residual income after charging the bonus.
Before the new investment:
5/105 x GH¢33,400 = GH¢1,590.48
After the new investment:
5/105 x GH¢41,000 = GH¢1,952.38
Percentage change in bonus:
(1,952.38 – 1,590.48) / 1,590.48 x 100 = 22.75%
- Tags: Bonus calculation, Investment Appraisal, Residual Income, Return on investment
- Level: Level 2
- Topic: Divisional Performance, Performance analysis
- Series: MAY 2021
- Uploader: Dotse