Question

Ayu Bhd (AB) 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 AB is increasing rapidly. The stores of the company, at an average, have a gross profit ratio of around 40%. AB assesses the performance of each of their stores individually. The expected return on investment (ROI) of AB is 10%. Some of the stores have been able to achieve an ROI above this target. Below is financial data given for two of AB's stores for the last year: Store C in Kuala Lumpur and Store D in Johor Bahru, yourself le feu Sales Gross Profit Net Profit Assets employed investment) Store C (RM'000) 1,720 724 150 1,170 Store D (RM'000) 1,350 570 100 720 Required: a) Discuss the past financial performance of Store C and Store D 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)

Answer 1

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Ayu Bhd.
Answer i
ROI= Net profit/Assets Employed	Store C	Store D	Discussion of financial performance
Net profit	150.00	100.00
Assets Employed	1,170.00	720.00
ROI	12.82%	13.89%	ROI of store D is better than C.
Answer ii
Gross Profit ratio = Gross profit/Sales	Store C	Store D	Discussion of financial performance
Gross Profit	724.00	570.00
Sales	1,720.00	1,350.00
ROI	42.09%	42.22%	Gross profit ratio of store D is slightly better than C.
Answer iii
Net Profit ratio = Net profit/Sales	Store C	Store D	Discussion of financial performance
Net profit	150.00	100.00
Sales	1,720.00	1,350.00
ROI	8.72%	7.41%	Net profit ratio of store C is better than D.
Answer iv
Residual Income= Net Profit- Expected return from investment
Expected return from investment= Investment amount* Rate of return
	Store C	Store D	Discussion of financial performance
Assets Employed	1,170.00	720.00
Expected rate of return	10%	10%
Expected return	117.00	72.00
Residual Income
Net profit	150.00	100.00
Expected return	117.00	72.00
Residual Income	33.00	28.00	Residual Income of store C is better than D.

2 disadvantages of ROI:

1. ROI may prompt managers to select that investments only which has high ROI or within the target of their ROI. This may be lead to foregoing profitable projects.

2. If decisions like bonus distribution or project allocation is done on the based of ROI then it may happened that those branches whose ROI is more but is efficient will get favorable preference then other departments.