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Should we include scrap value as an inflow for ROCE calculation?

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Should we include scrap value as an inflow for ROCE calculation?

  • This topic has 1 reply, 2 voices, and was last updated 6 months ago by LMR1006.
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  • November 19, 2024 at 5:16 am #713341
    aamna808
    Participant
    • Topics: 24
    • Replies: 9
    • ☆

    Backpay Co is considering investing $50,000 in a new machine. The machine will have scrap value of $10,000 at the end of its five-year life. It is expected that 20,000 units will be sold each year at a selling price of $3.00 per unit. Variable production costs are expected to be $1.65 per unit, while incremental fixed costs are expected to be $10,000 per year.

    Question
    2. What is the project’s return on capital employed, based on average investment?

    The ROCE I calculated is 36.7% because I included the scrap value in year 5’s cash flow, then averaged all cashflows, but that is not the case in the solution. The rest of my calculation is correct but I am a bit confused as to why we shouldn’t treat scrap value as an inflow for year 5, and one more thing to confirm, we only consider investment as an outflow in year 0 for payback period, not for ROCE calculation right. Please let me know. Thanks in advance!

    Solution:
    The correct answer is 30%.

    WORKING

    Annual cash flow = (20,000 × 1.35) – $10,000 = $17,000

    Annual depreciation = (50,000 – 10,000)/5 = $8,000

    Annual operating profit = 17,000 – 8,000 = $9,000

    Average investment = 1/2 (50,000 + 10,000) = $30,000

    ROCE = 9,000/30,000 = 30%

    November 19, 2024 at 5:54 pm #713361
    LMR1006
    Keymaster
    • Topics: 4
    • Replies: 1497
    • ☆☆☆☆☆

    The ROCE is the annual accounting profit (which is after depreciation) expressed as a % of the average investment.

    So the average investment is the investment + sales proceeeds from any scrap (or zero scrap value) / 2

    The ROCE is the same as the accounting rate of return which John explains in his free lectures on methods of investment appraisal.

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