11.1 Sohni Company

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Centennial College *

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MANAGERIAL

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Finance

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Apr 3, 2024

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Executive Summary Sohni Company is a retailer with four Canadian divisions; Western, Prairie, Central, and Eastern, where each division is treated as an investment centre. Currently, the company uses ROI to evaluate financial performance of the four divisions. There is an upcoming management meeting to discuss the performance of each division and to evaluate whether to invest in divisional projects for next year. The new president, who is a certified accountant, would like to see if using the RI method is more efficient for the company and present her findings at the meeting. The question of whether to keep the Eastern division open has come up in the past and will likely be revisited at the upcoming meeting. Issues  Should Sohni change its method of performance evaluation?  What is the divisional performance for 20x3?  Should Sohni pursue the proposed divisional projects for 20X4  Should Sohni close its Eastern division? Alternatives  Use RI and ROI method for 20x4  Evaluate divisional performance using ROI and RI for 20x3  Move forward with some, all, or none of the proposed projects for 20x4  Close the Eastern division or keep it open Analysis Appendix A shows that ROI in all divisions has performed exceptionally well in 20x3, with ROI ranging from 35.3% in the Western division, to an impressive 50% in the Eastern division, significantly higher than the required rate of return of 10%. RI also shows that financial performance has exceeded management expectations with residual income ranging from $800,000 in the Eastern Region to $3,800,000 in the Western Region. Appendix C shows that if the proposed divisional projects are accepted in 20x4, ROI will decrease in the divisions from 20x3, except for the Central division having a slight increase in ROI for 20x4. However, the projected RI in 20x4 would increase from 20x3 across all divisions, ranging from 2.1% in the Western division to a 22.5% increase in the Eastern division. To evaluate whether the Eastern division should remain open, the financial health was analyzed using two financial ratios. The first, Asset Ratio

Turnover, was calculated to determine how efficiently Sohni’s divisions use its assets to generate revenue, and the second, Net Profit Margin Ratio, was used to determine the amount of profit Sohni’s divisions produce from its total revenue. Conclusion It seems that Sohni would do well to switch to RI performance evaluation, as it gives a clearer picture of Capital Expenditures and whether they meet or exceed the required rate of return. While ROI is useful in determining the health of the company in terms of the amount of income generated relative to the size of its assets, RI better shows the generated income based on management expectations and can be more useful in evaluating future projects. Because the RI in the Central division will be increased by 12.5%, and 22.5% in the Eastern division in 20x4 over the RI in 20x3, Sohni should accept the projects in these divisions. The projects in the Western division and Prairie division will only increase RI by 2.1% and 9.6% respectively in 20x4 from 20x3, and therefore should be rejected. When evaluating the financial health of the Eastern division using the ratio analysis, it is clear that Sohni should keep the division open. Although the Eastern division appears to be the lowest performing division, in 20x3, its Asset Ratio Turnover is the highest amongst the divisions at 100% and Net Profit Margin is 28.6%, second only to the Prairie division at 30.5% Net Profit Margin. These ratios show how well the Eastern division is doing when it comes to generating revenue from its assets and its efficiency at controlling costs, with a high percentage of profit from its revenues.

Appendix A - Divisional ROI and RI 20x3: Western Prairie Central Eastern Revenue $11,000,000 $3,000,000 $9,000,000 $2,000,000 Less: Variable Costs $2,200,000 $600,000 $1,800,000 $400,000 Less: Fixed Costs $3,500,000 $800,000 $3,000,000 $600,000 Operating Income $5,300,000 $1,600,000 $4,200,000 $1,000,000 Total Assets $15,000,000 $3,500,000 $10,000,000 2,000,000 ROI 35.3% 45.7% 42% 50% Required Rate of Return 10% 10% 10% 10% Residual Income $3,800,000 $1,250,000 $3,200,000 $800,000 Appendix B - Potential Capital Expenditure for 20x4 Western Prairie Central Eastern Operating Income 20x3 $5,300,000 $1,600,000 $4,200,000 $1,000,000 Increase in Operating Income 20x4 $400,000 $200,000 $500,000 $300,000 Operating Income 20x4 $5,700,000 $1,800,000 $4,700,000 $1,300,000 Investment Required $3,200,000 $800,000 $1,000,000 $1,200,000 Total Assets 20x3 $15,000,000 $3,500,000 $10,000,000 $2,000,000 Total Assets 20x4 $18,200,000 $4,300,000 $11,000,000 $3,200,000 Combined ROI (%) (20x3 & 20x4) 31.3% 41.9% 42.7% 40.1% Combined RI ($) (20x3 & 20x4) $3,880,000 $1,370,00 0 $3,600,000 $980,000

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ROI of Project 12.5% 25% 50% 25% Appendix C - Effect on ROI and RI if 20x4 Projects are Accepted Western Prairie Central Eastern ROI 20x3 35.3% 45.7% 42% 50% ROI 20x4 if Project is Accepted 31.3% 41.9% 42.7% 40.1% Change in ROI if Project is Accepted (-4%) (-3.8%) 0.7% (-9.9%) RI 20x3 $3,800,000 $1,250,000 $3,200,000 $800,000 RI 20x4 if Project is Accepted $3,880,000 $1,370,000 $3,600,000 $980,000 Change in RI if Project is Accepted ($) $80,000 $120,000 $400,000 $180,000 Change in RI if Project is Accepted (%) 2.1% 9.6% 12.5% 22.5% Appendix D - Asset Ratio Turnover – 20x3 Western Prairie Central Eastern Revenue 20x3 $11,000,000 $3,000,000 $9,000,000 $2,000,000 Total Assets 20x3 $15,000,000 $3,500,000 $10,000,000 $2,000,000 Asset Turnover Ratio (Revenue/T otal Assets) 73.3% 85.7% 90% 100%

Appendix E - Net Profit Margin Ratio 20x3 Western Prairie Central Eastern Operating Income 20x3 $5,300,00 0 $1,600,000 $4,200,000 $1,000,000 Interest (12%) $636,000 $192,000 $504,000 $120,000 Income Before Taxes $4,664,00 0 $1,408,000 $3,696,000 $880,000 Income Taxes (35%) $1,632,40 0 $492,800 $1,293,600 $308,000 Net Income $3,031,60 0 $915,200 $2,402,400 $572,000 Revenue 20x3 $11,000,0 00 $3,000,000 $9,000,000 $2,000,000 Net Profit Margin (Net Income/Revenue) 27.6% 30.5% 26.7% 28.6%