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Hi All,
Question:
“Division A of Aigburth Co is considering a project which will increase annual net profit after tax by $30,000 but will require average inventory levels to increase by $200,000. The current target rate of return on investments is 13% and the imputed interest cost of capital is 12%
Based on the ROI and/or RI criteria, would the project be accepted?
Answer:
ROI- Yes
RI – YesROI calculated at 15% – accept
RI calculated at $6000 – acceptMy question is, on what basis would you accept a project when calculating RI?
I understand why you would accept on ROI as it is higher then the target rate, but the calculated RI is $6000 and I am not sure why they have accepted on that basis? Please help!
Thanks,
Vicki
If the RI is positive then it’s accepted or if its negative then it wnt b accepted
Farzana: Please do not answer in the Ask the Tutor Forum
Vicki: Farzana is correct in that if the RI is positive them we accept. It is because the investment of 200,000 is earning 30,000, which is more than the interest cost of 200,000 x 12% = 24,000.
RI is simply checking whether or not the investment is earning more than the cost of money of (in this case) 12%. If it is earning more then the RI will be positive and we accept; if it is earning less then the RI will be negative and we reject.I would like to ask, if the ROI and RI compare which one is better? Why? Thank you.
It is not a question of one being better – there is no ‘best’ one. It depends what we are doing with it.
If you watch the lecture I explain this and talk about the advantages and disadvantages.John thank you so much for your help . I have passed the exam today got 60% . Without ur help it was impossible to pass. U r really a great lecturer. Ur suggestion is just enough to get good marks n understandable.
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