In: Accounting
Question 1
Norway (Pty) Ltd is a divisionalised company, where the divisional
managers’ remuneration packages are linked to the return on
investment of their divisions. Return on investment is based on the
net book value of assets employed in the division at the beginning
of the financial year. On average, divisional managers remain in
their posts for a three-year period.
The manager of the Scandinavian division is considering two
mutually exclusive alternative proposals for investing in new
machinery. These proposals both involve an initial outlay of R250
000, but will yield different levels of savings over the life of
the machinery, which is estimated at five years, after which they
will have no residual value. Norway (Pty) Ltd ‘s depreciation, is
calculated on a straight-line basis.
The savings will give rise to increased cash flows as
follows:
Year
Machine
A
Cash flows
B
Cash flows
1
80 000
100 000
2
80 000
90 000
3
80 000
80 000
4
100 000
60 000
5
100 000
40 000
Required:
1. Appraise each project, using
a) return on investment, as described above
b) net present value, using the company’s cost of capital of
6%
15 marks
Based on your results from (1), explain which machine the
divisional manager is likely to choose and discuss the potential
conflict between performance measurement and investment
appraisal.