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Return on Investment & RI

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA MA – FIA FMA › Return on Investment & RI

  • This topic has 3 replies, 2 voices, and was last updated 11 years ago by John Moffat.
Viewing 4 posts - 1 through 4 (of 4 total)
  • Author
    Posts
  • April 14, 2014 at 1:29 pm #165264
    Shafiq
    Member
    • Topics: 4
    • Replies: 6
    • ☆

    Dear Sir,

    Appreciate if you could help me understand the answer for the following question.

    37. An investment division earns a return on investment of 15% and a residual income of $200,000. The cost of capital is 18%. A new project gives a return on capital employed of 16%.

    If the new project is accepted, what will happen to the investment division’s return on investment and residual income?

    Best Regards,
    Shafiq

    April 14, 2014 at 5:05 pm #165273
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54700
    • ☆☆☆☆☆

    The company is current earning an ROI of 15%. If they take on a new project giving a return of 16%, then the overall ROI must increase (because 16% is more than 15%).

    With regard to the RI, let me make up a few figures to try and make it clear.
    Just suppose that the new investment meant spending 10,000. Since it gives a return of 16%, this would mean extra profit of 1,600 a year.
    However, there would be extra notional interest of 18% (cost of capital) of 1,800.

    So…the total RI would fall by 200 (1,600 – 1,800).

    I invented the amount of the investment, but however much we are investing the RI must fall because the return of 16% is less than the cost of capital of 18%.

    April 28, 2014 at 3:03 pm #166592
    Shafiq
    Member
    • Topics: 4
    • Replies: 6
    • ☆

    Thank you, Sir. It is clear now.

    April 28, 2014 at 4:27 pm #166630
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54700
    • ☆☆☆☆☆

    You are welcome 🙂

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