Question

QUESTION 4 (25 MARKS) Catlia Bhd (CB) sells varieties of muslimah veils that has a number of stores across Peninsular Malaysia. The manager of the company is an ambitious person, and looking to expand her activities, by continuously adding the number of stores. The market of CB is increasing rapidly. The stores of the company, at an average, have a gross profit ratio of around 40% CB assesses the performance of each of their stores individually. The expected return on investment (ROI) of CB is 10%. Some of the stores have been able to achieve an ROI above this target. Below is financial data given for two of CB's stores for the last year: Store KL in Kuala Lumpur and Store JB in Johor Bahru, Sales Gross Profit Net Profit Assets employed investment) Store KL (RM'000) 2,064 868.8 180 1,404 Store JB (RM'000) 1,620 684 120 864 Required: a) Discuss the past financial performance of Store KL and Store JB using: i. ROI (4 marks) ii. Gross Profit Ratio (4 marks) iii. Net Profit Ratio (4 marks) iv. Residual Income (5 marks b) Discuss TWO (2) disadvantages of ROI as divisional performance measures (8 marks *** END OF QUESTIONS ***

Answer 1

a)

i) ROI :

KL - 12.82%

This is more than the expected returns of 10%, so this indicates that the Kaula lumpur division is giving good returns to Catlia bhd.

JB - 13.88%

This is also more than minimum returns expected and compared to KL division JB gives more returns.

ii) Gross profit:

KL - 42.09%

KL has more gross profit compared to company's average of 40%. So, KL division is under that divisions group which gives more returns compared to company's average.

JB - 42.22%

JB division also gives more gross profit compared to company's average. This is more than KL division gross profit ratio.

iii) Net profit ratio:

KL - 8.72%

JB - 7.41%

KL division has more net profit ratio compared to JB division. This indicates that JB division has more percentage of administrative and selling expenses compared to KL. Therefore, it results in less net profit in spit off more gross profit ratio.

iv) Residual income:

KL - RM 39600

JB - RM 33600

Both divisions are able to make income above the minimum expected income. This is favorable to company as a whole.

Solution -

ROI = (Net profit /assets employed)

ROI of KL = (RM 180000/RM 1404000)

= 0.1282

= 12.82%

ROI of JB = (RM 120000/RM 864000)

= 0.1388

= 13.88%

Gross profit ratio = Gross profit /sales

Gross profit ratio of KL = RM 868800/RM 2064000

= 0.4209

= 42.09%

Gross profit ratio of JB = RM 684000/RM 1620000

= 0.4222

= 42.22%

Net profit ratio = net profit /sales

Net profit ratio of KL = RM 180000/RM 2064000

= 0.0872

= 8.72%

Net profit of JB = RM 120000/RM 1620000

= 0.0741

= 7.41%

Residual income = net profit - (assets employed * minimum rate of returns )

Residual income of KL = RM 180000 - (RM1404000*10%)

= RM180000 - RM 140400

= RM 39600

Residual income of BL = RM 120000 - (RM 864000*10%)

= RM 120000 - RM 86400

= RM 33600

b) Disadvantages :

1. The divisionsl manager can be biased whole computing the ROI for his division, i.e. he can select only those investments that helps to increase division's ROI and ignore those projects which benefits business as a whole

2. As ROI is based on net profit, divisional manager can influence the computation of net profit by changing accounting procedures and policies. In this case the net profit figure may not reflect the actual performance of the division.