Reference no: EM132325775

Question

Telum Ltd manufactures electronic devices and competes on the basis of quality and leadingedge designs. The company has $1,750,000 invested in assets in its Mobile Phone Division. The operating profit before tax of the Mobile Phone Division this year is $325,000.

The Tablet Division has $6,000,000 invested in assets and an operating profit before tax this year of $1,050,000. The weighted average cost of capital for Telum (which is also the required rate of return) is 9%.

The CEO of Telum Ltd has told the manager of each division that the division that "performs best" this year will get a bonus.

Required:

(a) Calculate the return on investment (ROI) and residual income (RI) for each division, and briefly explain which manager will get the bonus based on these two measures.

(b) The manager of the Tablet Division is considering a proposal to invest $120,000 in a new quality testing system. It is estimated that the new system will decrease operating costs (and hence increase profits) by $13,000. Is the manager likely to accept the proposal if his  bonuses are based on divisional ROI? Would his decision be in the best interests of Telum Ltd?

(c) What are the advantages and disadvantages of residual income (RI) compared to return on investment (ROI)?

(d) The Mobile Phone Division has $525,000 of current liabilities, whereas the Tablet Division has only $105,000 of current liabilities. Given a tax rate of 30%, calculate the EVA for each division.

(e) The CEO of Telum Ltd is concerned that the focus on financial measures could have an adverse long-term effect on the viability of the company. Explain how the implementation of a balanced scorecard would help to address his concerns.