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Hello Sir,
Could you please hep me with the following question?
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 2500 to divisional profit next year after depreciation of 500. It has a carrying value of 6000 and could be sold for this amount. He would use the proceeds from the sale plus additional cash from head office to purchase a new machine for 15000. This new machine would add 5200 to divisional profit next year after depreciation of 2000.
What will be the expected 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 ROI calculation.
Answer:
The correct answer is: 30.9%Profit: 65’000 – 2500 + 5200 = 67’700
Capital employed: 210’000 – 6000 +15’000 = 219’00067’700/ 219’000 = 30,9%
My question is >
1) why are they not reducing depreciation from assets?
2 ) why are net current assets unchanged ( they should decrease by another 9000 ; the machine was bought for 15’000 ; 6000 was financed from the sale of the old machine and 9000 was financed by cash).
3) why is 15’000 added to non-current assets, if the question says that non-current assets are valued at the start of year carrying amount.I believe that it should look like this:
Profit: 85’000 – 3000 – 19500 + 5200 = 67’700 ( I agree with the profit figure)
Capital employed: 180’000 + 21’000 ( 30’000+6000 – 15’000) – 2000 = 199’000ROI: 67’700 / 199’000 = 34 %
Thank you in advance.
*small correction*
I believe that it should look like this:
Profit: 85’000 – 3000 – 21500 + 7200 = 67’700 ( I agree with the profit figure)
Capital employed: 180’000 + 21’000 ( 30’000+6000 – 15’000) – 2000 – 21’500 = 177’500ROI: 67’700 / 177’500 = 38.14 %
Thank you in advance.
The question says to use the carrying value at the start of the year for the non-current assets, so we do not subtract this years depreciation. The carrying value is already after subtracting the accumulated depreciation – the 20,000 is the depreciation for next year.
Automatically, when we use the carrying value at the start of the year we do remove the carrying value of any assets sold during the year, and add the value of any assets purchased during the year.
The current assets have been valued using the value at the start of the year, which is normal (and sensible as it is consistent with what you are told about the value of the non-current assets). It would be impossible to calculate the value at the end of the year anyway because other things would affect it that we don’t know about.
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