DIVISIONAL PERFORMANCE MEASUREMENT

Division B has now been offered an immediate opportunity to invest in new machinery at a cost of $2·12 million.
The machinery is expected to have a useful economic life of four years, after which it could be sold for $200,000.
Division B’s policy is to depreciate all of its machinery on a straight-line basis over the life of the asset. The
machinery would be expected to expand Division B’s production capacity, resulting in an 8·5% increase in
contribution per month.

Recalculate Division B’s expected annualised ROI and annualised RI, based on July’s budgeted operating
statement after adjusting for the investment. State whether the managing director will be making a decision
that is in the best interests of the company as a whole if ROI is used as the basis of the decision.

Answer
Division B’s ROI with investment
Depreciation = 2,120,000 – 200,000/48 months = $40,000 per month.
Net profit for July = 311k + ($600k x 8·5%) – $40k = $322k
Annualised net profit: $322k x 12 = $3,864k.
Opening net assets after investment = $23,200k + $2,120 = $25,320k.
ROI = $3,864k/25,320k = 15·26%
Therefore, Division B will not proceed with the investment, since it will cause a decrease in its ROI.

Good day sir,Pls i don’t understand why the depreciation was only removed from the net profit figure but included in the net assets calculation since depreciation is not controllable.