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Division X in Grate co has the following information available:
revenue 50000
operating costs 20500
fixed cost 11000
profit 18500
capital employed 150000half of the fixed costs for each divisions are allocated head office expenses. Grate co has cost of capital of 15%.
in order to try and improve current performance the manager if division X is considering 3 new projects:
project 1
capital investment 48000
profit 12000project 2
capital investment 100000
profit 22000project 3
capital investment 50000
profit 9000Question: if projects are ranked according to their ROI, which project will be the priority choice for division X.
A. project 1
B. project 2
C. project 3According to my calculations the ROI for each project is as follows:
Project 1 25%
project 2 22%
project 3 18%hence i chose A as the answr but the correct answer is C. please ecplain why project 3 would be chosen.
Currently, X is making a controllable profit of 50,000 – 20,500 – (1/2 x 11,000) = 24,000, and so the ROI = 24,000/150,000 = 17.1%
If they take project 1, the ROI becomes (24,000 + 12,000) / (150,000 + 48,000) = 18.2%
If they take project 3, the ROI becomes (24,000 + 9,000) / (150,000 + 50,000) = 16.5%Project 1 is better for them than project 3 🙂
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