ROCE (ARR)

A project involves the immediate purchase of an item of plant costing $110,000. It would generate annual cash flows of $24,400 for five years, starting in Year 1. The plant purchased would have a scrap value of $10,000 in five years, when the project terminates Annual cash flows are taken to be profit before depreciation. Average annual depreciation = ($110,000 – $10,000) ÷ 5 = $20,000 Average annual profit = $24,400 – $20,000 = $4,400 ROCE 4,400/ 60,000 × 100% = 7.33% This question is solved in Kaplan Study text Page no 50 (Test your understanding 1) They have deducted the average depreciation from the cash flow. But in the same chapter at Test your understanding 12 question. They Didn't do the same, they didn't deduct the avg depreciation charge from the cashflows. Question 12: Acorn plc is considering purchasing a new machine at a cost of $110,400 that will be operated for four years, after which time it will be sold for an estimated $9,600. Acorn uses a straight-line policy for depreciation. Note: calculated as average annual profits divided by the average investment. Average profit = $(39,600 + 19,600 + 22,400 + 32,400)/4 = $28,500 Average investment = $(110,400 + 9,600)/2 = $60,000 ROCE = $(28,500/60,000) × 100% = 47.5% The ROCE according to the book is 47.5% (without deduction of depreciation) My ROCE according to the question 1 is coming up 5.5%. Please tell which method is correct. Thanks.