Question

The Ste. Marie Division of Pacific Media Corporation just started operations. It purchased depreciable assets costing $43 million and having a four-year expected life, after which the assets can be salvaged for $8.6 million. In addition, the division has $43 million in assets that are not depreciable. After four years, the division will have $43 million available from these nondepreciable assets. This means that the division has invested $86 million in assets with a salvage value of $51.6 million. Annual depreciation is $8.6 million. Annual operating cash flows are $21 million. Depreciation is computed on a straight-line basis, recognizing the salvage values noted. Ignore taxes. Assume that the division uses beginning-of-year asset values in the denominator for computing ROI.

Required:

a. & b. Compute ROI, using net book value and gross book value. (Enter your answers as a percentage rounded to 1 decimal place (i.e., 32.1).)

	ROI Net Book Value Gross Book Value Year 1 % % Year 2 % % Year 3 % % Year 4 % %

Answer 1

a. & b.

Computation of ROI by using net book value and gross book value are:

ROI Net Book Gross Book Value Value Year 1 Year 2 Year 3 Year 4 14.42% 16.02% 18.02% 20.60% 14.42% 14.42% 14.42% 14.42%

Working Note:

1.

Computation of annual income is:

Annual income = Annual cash flow - Annual depreciation

= $21,000,000 - $8,600,000

= $12,400,000

Hence, the annual income is $12,400,000.

2.

I.

Computation of net investment by using net book value method for year 1 is:

Net investment for year 1 = Gross investment for year 1 - Accumulated depreciation for year 1

= $86,000,000 - $0

= $86,000,000

Hence, the net investment for year 1 is $86,000,000.

II.

Computation of ROI by using net book value method for year 1 is:

ROI for year 1 = (Annual income / Net book value of investment for year 1) * 100

= ($12,400,000 / $86,000,000) * 100

= 14.42%

Hence, the ROI for year 1 is 14.42%.

3.

I.

Computation of net investment by using net book value method for year 2 is:

Net investment for year 2 = Gross investment for year 2 - Accumulated depreciation for year 2

= $86,000,000 - $8,600,000

= $77,400,000

Hence, the net investment for year 2 is $77,400,000.

II.

Computation of ROI by using net book value method for year 2 is:

ROI for year 2 = (Annual income / Net book value of investment for year 2) * 100

= ($12,400,000 / $77,400,000) * 100

= 16.02%

Hence, the ROI for year 2 is 16.02%.

4.

I.

Computation of accumulated depreciation for year 3 is:

Accumulated depreciation for year 3 = Annual depreciation * 2

= $8,600,000 * 2

= $17,200,000

Hence, the accumulated depreciation for year 3 is $17,200,000.

II.

Computation of net investment by using net book value method for year 3 is:

Net investment for year 3 = Gross investment for year 3 - Accumulated depreciation for year 3

= $86,000,000 - $17,200,000

= $68,800,000

Hence, the net investment for year 3 is $68,800,000.

III.

Computation of ROI by using net book value method for year 3 is:

ROI for year 3 = (Annual income / Net book value of investment for year 3) * 100

= ($12,400,000 / $68,800,000) * 100

= 18.02%

Hence, the ROI for year 3 is 18.02%.

5.

I.

Computation of accumulated depreciation for year 4 is:

Accumulated depreciation for year 4 = Annual depreciation * 3

= $8,600,000 * 3

= $25,800,000

Hence, the accumulated depreciation for year 3 is $25,800,000.

II.

Computation of net investment by using net book value method for year 4 is:

Net investment for year 4 = Gross investment for year 4 - Accumulated depreciation for year 4

= $86,000,000 - $25,800,000

= $60,200,000

Hence, the net investment for year 4 is $60,200,000.

III.

Computation of ROI by using net book value method for year 4 is:

ROI for year 4 = (Annual income / Net book value of investment for year 4) * 100

= ($12,400,000 / $60,200,000) * 100

= 20.60%

Hence, the ROI for year 4 is 20.60%.

6.

Computation of ROI by using gross book value method for year 1 is:

ROI for year 1 = (Annual income / Gross investment) * 100

= ($12,400,000 / $86,000,000) * 100

= 14.42%

Hence, the ROI for year 1 is 14.42%.

7.

Computation of ROI by using gross book value method for year 2 is:

ROI for year 2 = (Annual income / Gross investment) * 100

= ($12,400,000 / $86,000,000) * 100

= 14.42%

Hence, the ROI for year 2 is 14.42%.

8.

Computation of ROI by using gross book value method for year 3 is:

ROI for year 3 = (Annual income / Gross investment) * 100

= ($12,400,000 / $86,000,000) * 100

= 14.42%

Hence, the ROI for year 3 is 14.42%.

9.

Computation of ROI by using gross book value method for year 4 is:

ROI for year 4 = (Annual income / Gross investment) * 100

= ($12,400,000 / $86,000,000) * 100

= 14.42%

Hence, the ROI for year 4 is 14.42%.