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An investment centre has prepared the following forecasts for the next financial year.
Operating profit before depreciation 85,000
Depreciation 20,000
Net current assets at beginning of year 30,000
Carrying value of non-current assets at beginning of year 180,000The centre manager is now considering whether to sell a machine that is included in these forecasts. The machine would add $2,500 to divisional profit next year after depreciation of $500. It has a carrying value of $6,000 and could be sold for this amount. They would use the proceeds from the sale plus additional cash from Head Office to purchase a new machine for $15,000. This new machine would add $5,200 to divisional profit next year after depreciation of $2,000. What will be the expected return on investment (ROI) for the division next year, assuming that the manager acquires the new machine and that non-current assets are valued at the start of year carrying amount for the purpose of the ROI calculation?
answer 30.9%
profit 65000-2500+5200 = 67700
capital employed = 210000-6000+15000 = 219000
67700/219000 = 30.9%
why doesnt we include the effect of depreciation in the calculation?
nevermind i just realised the question stated the carrying amount and not nbv haha.
But i also confused on the effect of machine purchase, doesnt it contra with each other?Dt machinery 15000
Ct cash 15000making the capital employed only reduce by 6000? or is the statement “head office purchase the new machine of 15000” is the reason that the 15000 is included in the calculation because they purchased it for the division?
The capital employed is calculated by subtracting the carrying value of the non-current assets at the beginning of the year ($6,000) and adding the cost of the new machine ($15,000) to the capital employed at the start of the year ($210,000), which gives us a total capital employed of $219,000.
So the machine purchase, the $15,000 cost of the new machine is included in the calculation of the capital employed because it represents an investment made by the division. The purchase of the new machine is expected to contribute to the division’s profit, which is why it is included in the calculation..but doesnt the purchase of machine going to make a contra? increase in machine 15000 and decrease in cash 15000
But it clearly states:
They would use the proceeds from the sale plus additional cash from “HEAD OFFICE” to purchase a new machine for $15,000. This new machine would add $5,200 to divisional profit next year after depreciation of $2,000.
And you are asked to calculate :
What will be the expected return on investment (ROI) for the DIVISIONThe difference between Division and the company as a whole is critical
If it says division it means division!
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