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Hello sir
In this question
Melton Co has many divisions which it evaluates using Return on Investment (ROI) and Residual Income (RI) measures. The Mowbray division has net assets of $24 million at 30 September 2014. In the year to 30 September 2014 it earned profit before interest and tax of
$3·6 million. The appropriate cost of capital for the Mowbray division is 12%. During the year to 30 September it paid interest of $0·6 million.
What are the ROI and RI for the year to 30 September 2014?
In answer said ROI is 15% , I understand that but RI is RI = $3·6m – ($24m × 12%) = $0·72m
My question is why did not mines interest of $0.6 million?When measuring the performance (whether using ROI or RI) we always take the profits before any tax. The reason is that tax is not something that can be controlled by the division – if (for example) the state increases the rate of tax then that is not something that the division can be made responsible for.
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