Hi sir. I have a question regarding f5 june 2015 q1. A division is considering investing in capital equipment costing $2·7m. The useful economic life of the equipment is expected to be 50 years, with no resale value at the end of the period. The forecast return on the initial investment is 15% per annum before depreciation. The division’s cost of capital is 7%.
What is the expected annual residual income of the initial investment?
A $0
B ($270,000)
C $162,000
D $216,000
Answer: C
Divisional profit before depreciation = $2·7m x 15% = $405,000 per annum. Less depreciation = $2·7m x 1/50 = $54,000 per annum.
Divisional profit after depreciation = $351,000
Imputed interest = $2·7m x 7% = $189,000
Residual income = $162,000.
My question is why for the capital employed we dont deduct the depreciation per annum? Why is the capital employed used 2.7m?
Thank you