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- December 13, 2017 at 11:23 pm #423144
Good morning, could you please help with the following question.
Budgeted statement of Division B for the month of July is shown below:
Sales revenue 1,300,000
Less variable costs (700,000)
Contribution 600,000
Less fixed costs (289,000)
Net profit 311,000
Divisional net assets 23,200,000
Division B has now been offered an immediate opportunity to invest in a new machinery at a cost of 2,120,000. The machinery is expected to have a useful economic life of 4 years, after which it could be sold for 200,000. Division’s B policy is to depreciate all of its machinery on a straight- line basis over the life of an asset.The machinery would be expected to expand Division B’s production capacity , resulting in an 8,5% increase in contribution per month.
Question asks for calculation of annualised ROI if the investment is accepted. The answer is as follows:
Depreciation 2,120,000 – 200,000)/48months = 40,000 per month
Net profit for July 311,000+ 600,000×8,5% – 40,000 = 322,000
Annualised net profit 322,000×12 = 3,864,000
Opening net assets after investment 23,200,000 + 2,120,000 = 23,320,000ROI: 3,864,000/23,320,000 x100% = 15,26%
My doubts:
1.Is it right to include in total net assets (in ROI calculation) a new asset at its cost without reducing it by residual value of 200,000?
2.Is it a rule that we reduce operating profit by depreciation when calculating ROI and RI?Thank you!
December 14, 2017 at 7:35 am #4231701. Unless the question says to do different, it is normal not to depreciate the assets on the basis that it is the value at the start of the year (plus the cost of new assets bought) that earns the profit for the year.
2. Profit is always after charging depreciation.
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