Division Y of Chardonnay currently has capital employed of $100,000 and earns an annual profit after depreciation of $18,000. The divisional manager is considering an investment of $10,000 in an asset which will have a ten-year life with no residual value and will earn a constant annual profit after depreciation of $1,600. The cost of capital is 15%.
Calculate the following and comment on the results.
(i) The return on divisional investment before and after the new investment
(ii) The divisional residual income before and after the new investment
解析：(i) Return on divisional investment (ROI)
Before investment After investment
Divisional profit $18,000 $19,600
Divisional investment $100,000 $110,000
Divisional ROI 18.0% 17.8%
The ROI will fall in the short term if the new investment is undertaken. This is a problem which often arises with ROI, as noted in part (a) of this solution.
(ii) Divisional residual income
The residual income will increase if the new investment is undertaken. The use of residual income has highlighted the fact that the new project returns more than the cost of capital (16% compared with 15%).
