The Divisional Managers of West Plc Have Requested That the Method

question 15

Multiple Choice

The divisional managers of West plc have requested that the method for calculating bonuses at the year be reviewed. Senior managers at the head office have proposed that a bonus of £40,000 will be paid to the divisional manager who has the best return on investment (ROI) of the 3 divisions and this policy is consistent with previous years. Divisional managers want the senior managers to take into account controllable costs and profits and residual income (RI) when deciding bonuses and also to include non-financial measures of performance. The main reason given by the head office for using ROI is that it is understood by all managers and that it is used by external analysts.
Summary of Management Accounts to 31 December 1997
$\begin{array}{|l|l|l|l|}\hline & \text { Southern }(£) & \text { Eastern }(£) & \text { Western }(£) \\\hline \text { Sales } & 5,400,000 & 5,000,000 & 5,590,000 \\\hline \text { Controllable costs } & 3,700,000 & 3,502,000 & 3,660,000 \\\hline \text { Head Office Charges } & 998,000 & 1,282,000 & 1,170,000 \\\hline \text { Net Profit } & 702,000 & 716,000 & 760,000 \\\hline\end{array}$

Capital Employed
$\begin{array}{|l|l|l|l|}\hline & \text { Southern }(£) & \text { Eastern }(£) & \text { Western }(£) \\\hline \text { Total Investment } & 4,700,000 & 5,100,000 & 5,200,000 \\\hline \text { Controllable Investment } & 4,000,000 & 4,100,000 & 4,274,000 \\\hline\end{array}$
Cost of Capital
The head office has estimated that the group cost of capital is 10%
Financial and non-financial measures of performance
The divisional managers normally report on a wide range of financial measures each month to the head office but only use non-financial measures internally and each divisional manager is allowed to use their discretion when deciding on the range and number of measures to use.
- Calculate the Net Residual Income for the Southern Division

• A)£1,000,000.
• B)£1,200,000
• C)£1,300,000.
• D)£232,000.

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Definitions:

NPVGO

Net Present Value of Growth Opportunities; a valuation method that calculates the present value of investment opportunities a company is expected to undertake in the future.

Above Average P/E Multiple

A valuation metric indicating that a company's current share price is higher relative to its per-share earnings than the industry or overall market average.

Risk-adjusted Equity Cost

A method of determining the cost of equity capital that incorporates the risk associated with the equity investment.

Price Earnings Ratio

A valuation metric that compares a company's share price to its per-share earnings, used to evaluate if a stock is over or under-valued.