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John Moffat.
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Eunice03
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A division is considering investing in capital equipment costing $2.7 million. The useful economic life of the equipment is expected to b 50yrs,with no resale value at the end of the period. The forecast ROI is 15% per annum before depreciation. The division’s cost of capital is 7%?
The answer was
Divisional profit before depreciation=2.7m x 15%=$405,000 per year
Less depreciation=$2.7m x1/50=$54,000 per year
Divisional profit after depreciation=$351,000
Imputed interest=$2.7m x 7%=$189,000
Residual income= $162,000Good day sir,Pls I don’t understand why they used the capital equipment value without depreciation to calculate the imputed interest.
John Moffat
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The forecast divisional profit has been calculated after depreciation.
The imputed interest is calculated on the amount that they are considering investing, which is $2.7M.
Eunice03
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Thank you sir
John Moffat
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You are welcome.
Eunice03
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