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I’m genuinely sorry if this has already been asked and answered, I tried searching but didn’t find the answer.
In one of the MCQs in the Kaplan Kit regarding ROCE, we have been provided with the “net value of all assets and liabilities” at the start of the year as well as a different figure for the end of the year.
My initial instinct was to either take the year-end figure or an average of the two, but the answer at the back shows that we take the start-of-the-year figure. Is this a mistake or is the logic something like we’re taking the start figure because that’s probably what we generated our profits from as opposed to whatever we have accumulated by the end? I hope that made sense.
Thankyou!
There is no firm rule about this.
The logic is as you have written – that it is the assets at the start of the year that will have earned the profits for the year.
Do that in the exam unless, obviously, the question says to do different.
Thankyou, that makes sense! 🙂
Similar to this question, there’s another one where we’re only provided with the following information for a new project:
1. Increase in profit figure ($12,000)
2. Increase in average receivables level figure ($100,000)
3. R.O.I target for company (10%)
4. Divisions Current R.O.I Level (13%)
5. Notional Interest Rate (9%)They’ve then asked us to figure out on the basis of result of which of the two, (R.I or R.O.I) will the manager make decision in the interest of the company as a whole!
What I don’t understand is the relevance of the Receivables in the required calculations? Also considering the lack of information on Capital Employed, how can we be expected to suggest an answer in this situation?
(The suggested answer claims BOTH figures’ result will motivate the manager to make the decision in favour of the company as a whole!)
It is hard for me to answer without seeing the full question.
However, higher average receivables will mean higher ‘assets – current liabilities’ (which is the same as the total long-term investment in the division) and is therefore relevant for the calculation of the ROI and RI.
The exact question reads:
Division D of Erie Ltd is considering a project which will increase annual profit by $15,000, but will require average receivables to increae by $100,000. The company’s target return on investment is 10%, and the imputed interest cost of capital is 9%. Division D currently earns a return on investment of 13%.
Would the return on investment (ROI) and Residual Income (RI) performance measures motivate the manager of Division D to act in the interest of Erie Ltd as a whole?
A. The ROI would, but the RI wouldn’t
B. The RI would, but the ROI wouldn’t
C. Both would motivate
D. Neither would motivateWhat I wrote before still applies.
The investment in D increases by $100,000 in order to earn the extra $15,000.
The investment does not have to be in non-current assets – any increase in the assets is extra investment in the division.Ohhh! I didn’t know that the nature of assets is irrelevant in this case; your answer clarifies everything!
You’re a lifesaver, thankyouuu Sir! 🙂
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