Question

The Ste. Marie Division of Pacific Media Corporation just started operations. It purchased depreciable assets costing $45million and having a four­-year expected life, after which the assets can be salvaged for $9 million. In addition, the division has $45 million in assets that are not depreciable. After four years, the division will have $45 million available from these nondepreciable assets. This means that the division has invested $90 million in assets with a salvage value of $54 million.Annual depreciation is $9 million. Annual operating cash flows are $25 million. In computing ROI, this division uses end ­of­ year asset values in the denominator. Depreciation is computed on a straight­line basis, recognizing the salvage values noted. Ignore taxes. Assume that all cash flows increase 10 percent at the end of each year. This has the following effect onthe assets’ replacement cost and annual cash flows:

End of Year Replacement Cost $90,000,000 x 1.1 = $ 99,000,000 $99,000,000 x 1.1 = $108,900,000 Etc. Annual Cash Flow $25,000,000 x 1.1 = $27,500,000 $27,500,000 1.1 = $30, 250,000 Etc. Depreciation is as follows. Year for the Year $ 9,900,000 10,890,000 11,979,609 13,176,900 "Accumulated" $ 9,900,000 (-10 x $99,000,000) 21,780,000 (200 x 108,900,000) 35,937,000 52,707,600 Note that 'accumulated" depreciation is 10 percent of the gross book value of depreciable assets after one year, 20 percent after two years, and so forth. Required: a. & b. Compute ROI using historical cost, net book value and gross book value. c. & d. Compute ROI using current cost, net book value and gross book value.

Answer 1

Solution:

a & b. ROI using Historical Net book value and gross book value

Year	Net Book Value	Gross Book Value
Year 1	= (27,500,000-9,000,000)/(90,000,000-9,000,000) = (18,500,000/81,000,000) = 22.8%	=(27,500,000-9,000,000)/90,000,000 =(18,500,000/81,000,000) =20.6%
Year 2	= (30,250,000 - 9,000,000)/(90,000,000 - (2 x 9,000,000)) =(21,250,000/72,000,000) = 29.5%	(30,250,000 -9,000,000)/90,000,000 =(21,250,000/ 90,000,000) = 23.6%
Year 3	= (33,275,000 - 9,000,000)/(90,000,000- (3 x (9,000,000)) =(24,275,000/63,000,000) = 38.5%	(33,275,000 - 9,000,000)/90,000,000 =(24,275,000/90,000,000)=27.0%
Year 4	= (36,602,500 - 9,000,000)/(90,000,000- (4 x (9,000,000)) = (27,602,500/54,000,000) = 51.1%	(36,602,500 - 9,000,000)/90,000,000 = (27,602,500/90,000,000) = 30.7%

c & d. ROI using Current Net book value and gross book value

Year	Net Book Value	Gross Book Value
Year 1	=(27,500,000-9,900,000)/(99,000,000-9,900,000) =(17,600,000/ 89,100,000) = 19.8%	(27,500,000- 9,900,000)/99,000,000 =(17,600,000/99,000,000) = 17.8%
Year 2	= (30,250,000 - 10,890,000)/(108,900,000- 21,780,000) =(19,360,000/87,120,000) = 22.2%	(30,250,000 - 10,890,000)/108,900,000 =(19,360,000/108,900,000) = 17.8%
Year 3	=(33,275,000 - 11,979,000)/ (119,790,000 - 35,937,000) =(21,296,000/83,853,000)= 25.4%	(33,275,000 - 11,979,000)/ 119,790,000 = 21,296,000/119,790,000 = 17.8%
Year 4	= (36,602,500 - 13,176,900)/( 131,769,000 - 52,707,600) =(23,425,600/79,061,400) = 29.6%	= (36,602,500 - 13,176,900)/ 131,769,000 =(23,425,600/131,769,000)= 17.8%