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In ROI example 1 of the notes.
We compare current investment and new investment ROI to assess the performance of the manager is based on current investment vs new investment.
current investment = (82000 / 500000) = 16.4%
new investment = (99000 / 600000) = 16.5%We compare new investment and targeted ROI to assess the performance of the company based on new investment vs targeted ROI.
new investment = (17000 / 100000) = 17%
targeted ROI = 15%BUT why do we calculate the performance of the company based on additional profit and capital employed? Why do not we calculate it based on current investment like this (82000 / 500000) = 16.4%?
Have you watched the lectures working through this chapter, because I do explain all of this in the lectures? 🙂
Yes, I watched the lecture but maybe I didn’t get this.
Just like we assess the performance of the manager by calculating the ROI with new investment like this (99000 / 600000) = 16.5%.
Why don’t we actually use this way to assess the performance of the company with new investment. Because to calculate the performance of the company why do we only take the additional profit and additional capital employed?
Depending on the information given in the question and the requirements of the question you can do either – they will give the same decision.
In your lecture, you calculate the new investment of the company based on additional profit and capital investment but you maybe it is a mistake because it is the manager that has made a new investment by investing additional capital investment of $100000 to make a profit of $17000 return ROI of 17% (not the company).
The company has made capital investment of $500000 to make a profit of $82000 gives ROI of 16.4%. This new investment is compared with target ROI of 15%. Since the company has done well by making a new investment so it is financially viable.
The investment that the division (or manager) has made is actually the profit of $82000 and capital investment of $500000 gives ROI of 16.4% which is compared with new investment making a profit of $99000 and capital investment of $600000 return ROI of 16.5%. Since the company has done well by making a new investment so it is financially viable.
Thats what I was saying!
If the divisional managers performance is being measured using ROI then he will only invest in new projects that improve the ROI.
If the ROI is currently 16.4% then a new investment that gives a return of more than 16.4% will increase the overall ROI and he will therefore make the new investment. If the new investment gives a return of less than 16.4% then the overall ROI of the division will fall and therefore he will not make the new investment.
The manager is only concerned with what happens to the ROI of his division (whatever target return the company might have) which is one of the problems with ROI and why RI is maybe a better way of measuring performance.
Thanks for your answer 🙂
Could you please tell me the way opportunity cost (ie lost contribution) in material and labor is calculated in relevant costing questions?
I know it depends on the question but is there any usual way?
And opportunity cost is calculated when we have limited resources such as material kilos and labour hours are not enough to satisfy both parties (To decide between the relevant contract and existing work). Whether we should put the kilos and labour into relevant contract or use them into the usual work.
In future you must start a new thread when you are asking about a different topic. The reason is that we do not offer free private tuition and our answers are there to benefit everyone – many students use the search box to find answers to question that they had problems with themselves.
An opportunity cost is the lost income that occurs as a result of doing a new contract. Most commonly is occurs for the reasons you state in your latest post, but as you wrote it does depend on the information in the question.
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