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Hi,
I’m a bit stuck on a question where I need to calculate ROI. The scenario gives NPV calculations for three different divisions, and also states that ROI is calculated using average capital employed during the year, and that depreciation is on a straight line basis.
My question is: would I be required to use the net cash inflow or the PV figure from the given NPV calculation?
For example, the following NPV calculation for one division:
North Project:
Net cash inflow/outflow: PV at 12%
Yr0 (24000) (24000)
Yr1 6000 5358
Yr2 8000 6376
Yr3 13500 9612
Yr4 10500 6678So what I have done is:
Depreciation = 24000/4 = 6000 per year
Yr 1 – 24000+(24000-6000)/2 = 21000 average capital employed
6000/21000 = 28.6% ROIBut as I get towards years 3 and 4, my ROI is coming out over 100% and I don’t feel like that is right…! Can you advise where I am going wrong with this?
Thank you for your help!
As time passes the capital invested a project decreases (because of accumulated depreciation. Inevitably this means that both ROI and RI rise during the project – unless something like annuity depreciation is used..
Ok… so would I be expected to use annuity depreciation in this question then?
Having thought about it overnight as well, surely I would need to deduct the depreciation from the NPV cash flow to turn it into profit (as ROI uses profits rather than cash flows, and cash flows are all I have to work with)?
And final question – if I am not supposed to use annuity depreciation (not something that’s been covered in my course as far as I am aware…) then would it really be reasonable to expect an ROI of 350%?!
I understand that as the capital invested decreases the ROI will rise, but I can’t understand why this question would expect such a high ROI which is why I’m so confused by it..
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