ROI

Q302- (BPP REVISION KIT)
At the beginning of 20X2, a division has capital employed, consisting of NCAs of $2 million (at NBV) and working capital of $0.2 million. These are expected to earn a profit in 20X2 of $0.5 million, after depreciation of $0.4 million. A new machine will be installed at the beginning of 20X2. It will cost $0.8 million and will require an additional $0.1 million in working capital. It will add $0.35 million to divisional profits before deducting depreciation. This machine will have a 4-year life and no residual value: depreciation is by the straight-line method. When calculating ROI, capital employed is taken at its mid-year value.

What is the expected ROI of the division in 20X2?
A. 21.7%
B. 23.2%
C. 24.1%
D. 26%

Answer: B – 23.2%

The correct answer is 23.3%.
Capital employed at the start of 20X2 = $2 million + $0.2 million + $0.8 million + $0.1 million = $3.1 million

Capital employed at the end of 20X2 is the capital employed at the beginning of the year minus depreciation of $0.4 million on the ‘old asset’ and $0.2 million on the ‘new asset’.

Capital employed at the end of 20X2 = $1.6 million + $0.2 million + $0.6 million + $0.1 million = $2.5 million

Mid year capital employed = $(3.1 m + 2.5m) / 2 = $2.8 m

Profit = $0.5 m + $0.35 m – depreciation $0.2 m = $0.65 m

ROI = 0.65 / 2.8 = 0.232 = 23.2%

Doubt- Can you please explain how we calculate the depreciation on the ‘new asset’ ($0.2m)?