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Hi sir, I would like to ask when we calculate ROI and RI,
we need to calculate ROI like using CURRENT operating profit+NEW operating profit generated by the new investment/ CURRENT capital employed + NEW capital employed
OR
NEW operating profit/NEW investment??
How about RI also?
May I ask the decision rule for RI is it when it is positive, we will definitely agree?
It depends what the question asks for, but you will end up with the same decision doing it either way.
When the RI is positive, then on this criteria the new investment should be accepted.
This is all explained in my free lectures on performance measurement. The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.
How about the following question? because as to what I saw in the BPP answer, the answer uses new operating profit/new investment to calculate only???
BPP revision kit
12 An investment centre in a manufacturing group produced the following results in the previous financial year:
£’000
Operating profit 360
Capital employed: non-current assets 1,500
current assets 100
For the purpose of performance measurement, non-current assets are valued at cost. The investment centre is considering a new investment that will increase annual operating profit by £25,000, and will require an
investment of £100,000 in a non-current asset and an additional £30,000 in working capital.
Will the performance measurement criteria of (1) Return on Investment (ROI) and (2) residual income (RI) motivate the centre manager to undertake the investment?
Assume notional capital charge of 18% on divisional capital.
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