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MCS - C8 - ROI RI Based Measures

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32 views3 pages

MCS - C8 - ROI RI Based Measures

Uploaded by

Nhật Minh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Example 8.

1
An investment centre has reported the following results.
Iterms Current year Previous year
($000) ($000)

Sales 600 600


Gross profit 180 210
Net profit 24 30
Net sales at beginning of year 200 180
Required:
Discuss the financial performance of the investment centre. ROI is measured using net assets at
the beginning of the year.

Example 8.2
A division has net assets of $800,000 and makes an annual profit of $120,000. It should be
assumed that if the investment described below is not undertaken, the division will continue to
have net assets of $800,000 and an annual profit of $120,000 for the next four years.
The divisional is considering an investment in a new item of equipment that would cost $80,000.
The estimated life of the equipment is four years with no residual value. The estimated additional
profit before depreciation from the investment is as follows:
Year $
1 20,000
2 25,000
3 35,000
4 40,000
The asset will be depreciated on a straight-line basis.
Required:
a. What would be the ROI on this investment? ROI should be measured on the basis of the
average net assets employed during the year.
b. Would the investment centre manager decide to undertake this investment or not?

Example 8.3
The same example that was used in the previous section to illustrate ROI will be used here to
lustrate residual income.
An investment centre has reported the following results.
Iterms Current year Previous year
($000) ($000)
Sales 600 600

Gross profit 180 210


Net profit 24 30
Net sales at beginning of year 200 180
The division has a cost of capital of 10%, which is applied to net assets at the beginning of the
year to calculate notional interest.
Required:
How would the financial performance of the investment centre be assessed if residual income is
used as the main measure of performance?

Example 8.4
The difference between ROI and residual income can be illustrated by returning to the previous
example that was used to illustrate the ettect of ROl on investment decision-making.
A division has net assets of $800,000 and makes an annual profit of $120,000. It should be
assumed that if the investment descrbed below is not undertaken, the division will continue to
have net assets of $800,000 and an annual profit of $120,000 for the next tour ears. The
division's financial pertormance is measured using residual income, and the division's cost of
capital is 12%.
The divisional is considering an investment in a new item of equipment that would cost $80,000.
The estimated life of the equipment is four years with no residual value. The estimated additional
profit betore depreciation trom the investment is as follows:
Year $
1 20,000
2 25,000
3 35,000
4 40,000
The asset will be depreciated on a straight-line basis.
Required:
a. What would be the annual residual income on this investment? Notional interest should
be calculated on the basis of the average net assets employed during the year.
b. Would the investment centre manager decide to undertake this investment or not!
Example 8.5
A company has two divisions, Small and Big. Big Division has net assets of $8 million and
makes an annual profit of $900,000. Small Division has net assets of $400,000 and makes an
annual profit of $90,000. The cost of capital for both divisions is 10%.
Required: Compare the performance of the two divisions using:
a. ROI
b. Residual income.

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