1. avatar says

    Sir, please help me out with this question.
    A company has capital employed of $200,000. It has a cost of capital 12% per year. Its residual income is $36,000.
    What is the company’s return on investment?

    • Profile photo of John Moffat says

      (In future please ask questions in the Ask the Tutor forum rather than as a comment on a lecture).

      You know what the notional interest is (12% x $200,000). You know what the residual income is, so you can add back the interest to get the profit.

      The ROI is the profit as a percentage of the investment of 200,000.

  2. Profile photo of drrob1983 says

    I was thinking about the problem of ROI vs RI.
    Surely, the RI can be expressed as a percentage of net assets thereby allowing fair comparison between divisions?

    in your example, you show 50,000 return on 400,000 net assets.
    This generates an ROI of 12.5%
    a 10% return would be 40,000
    the RI would be 10,000
    the RI as a percentage of net assets would be 2.5%, which is the 12.5% ROI less the desired 10% return

    So this problem, one would imagine, is not as insurmountable as first suggested.

    • Profile photo of John Moffat says

      What you have written is true. However, as far as the exam is concerned it is simply a question of appreciating that although ROI is by far the most common way of measuring performance and is the most obvious way, it can lead to a loss of goal congruence. RI avoids the loss of goal congruence problem. In practice there is no ‘rule’ as to how to approach measuring performance and a company could develop its own ‘rule’ – the exam is just expecting you to be aware of the problems and to be able to calculate ROI and RI.

      • Profile photo of drrob1983 says

        I understand :-)

        Its not so much the maths (although that is important), its the relative merits of each method – as you say, goal congruence!

  3. Profile photo of Imran says

    Dear sir, i really need your help with this question, PLEASE HELP ME!

    Year ended oct 2003 Year ended oct 2004
    Revenue $ 5.75 Million $ 6 Million
    Number of styles 22 25
    Net profit $ 345,000 $ 348,000
    Market research cost $ 200,000 $ 150,000

    Required: Calculate Increase in sales per $ of market research.

    • Profile photo of John Moffat says

      Capital budgeting is another name for investment appraisal, which is dealt with in Chapter 21 (and the lecture that goes with it).

      There is no chapter in spreadsheets – the Course Notes are not Study Texts, they are notes that we use on courses. We do not teach spreadsheets on the courses because most students are familiar with them from work (and there are never many questions in the exam).

  4. avatar says

    Thank you for the great lectures John. In Test Question 4, the answer indicates that the target rate of return = cost of finance. Are these two terms interchangeable? or is there a play in the question? If cost of finance means as it does [interest payable on an investment loan (?) ], shouldn’t we consider this a cost? which reduces the profit? Many thanks!

  5. avatar says

    Hi John Moffat ..after really struggling to get a handle of MA2 , failing it in June ,to passing both Ma2 and Fma today in the CBE exam 70% in one and 64% in the other , it was all down to your fma lectures . Thank you so much !!!!

  6. avatar says

    How we can distinguish in exam:
    1. performance measurement – ROI or ROCE – (profit/capital employed)* 100% and
    2.divisional performance measurement – also is ROI !!!! ( controllable profit/controllable investment) * 100%.
    What they meant by investment ( I do not understand , exactly which figures will be , if we look at the balance sheet)

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