Mock Exam Q

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November 29, 2015 at 6:59 am #286049
alawi sayed
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Hi Sir,

A division is considering a capital investment of $6.5 M,
The expected life of the investment is 40 years with no resale value at the end of the period,
The forecast return on investment is 20% PA before depreciation .the division cost of capital is 10%

What is the expected residual income of the initial investment

I got $ 650000

But the correct answer is 487500

Thank you Very much,
November 29, 2015 at 8:29 am #286073
John Moffat
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The profit will be 20% x $6.5M = $1,300,000 p.a. before depreciation.
The depreciation will be $6.5M / 40 = 162,500
Therefore the profit after depreciation = 1,137,500

Therefore the residual income = 1,137,500 – (10% x $6.5M) = 487,500
November 29, 2015 at 12:08 pm #286122
alawi sayed
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Thanks a lot,

So we should always consider the profit after depreciation ,and does it mean that we should take the net profit,

Thanks for help,
November 29, 2015 at 2:10 pm #286135
John Moffat
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Yes – always after depreciation (unless obviously specifically told otherwise, which is very unlikely).
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