Question

The Ste. Marie Division of Pacific Media Corporation just started operations. It purchased depreciable assets costing $55 million and having a four-year expected life, after which the assets can be salvaged for $11 million. In addition, the division has $55 million in assets that are not depreciable. After four years, the division will have $55 million available from these nondepreciable assets. This means that the division has invested $110 million in assets with a salvage value of $66 million. Annual depreciation is $11 million. Annual operating cash flows are $30 million. In computing ROI, this division uses end-of-year asset values in the denominator. Depreciation is computed on a straight-line 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 on the assets’ replacement cost and annual cash flows.

End of Year	Replacement Cost						Annual Cash Flow
1	$	110,000,000	× 1.1 =	$	121,000,000		$	30,000,000	× 1.1 =	$	33,000,000
2	$	121,000,000	× 1.1 =	$	133,100,000		$	33,000,000	× 1.1 =	$	36,300,000
3	Etc.						Etc.
4

Depreciation is as follows.

Year	For the Year			"Accumulated"
1	$	12,100,000		$	12,100,000		(= 10% × $121,000,000)
2		13,310,000			26,620,000		(= 20% × 133,100,000)
3		14,641,000			43,923,000
4		16,105,100			64,420,400

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

a&b

	Net book Value	gross book value
Year 1	(33000000-11000000)/(110000000-11000000) = 22.2%	(33000000-11000000)/110000000 =20.0%
Year 2	(36300000-11000000)/(110000000-(2*1100000)) = 28.8%	(36300000-11000000)/110000000 = 23.0%
Year 3	(39930000-11000000)/(110000000-(3*11000000) = 37.6%	(39930000-11000000)/110000000 = 26.3%
Year 4	(43923000-11000000)/(110000000-(4*11000000) = 49.9%	(43923000-11000000)/110000000 = 29.9%

c & d

	Net book value	Gross book value
Year 1	(33000000-12100000)/(121000000-12100000) = 19.2%	(33000000-12100000)/121000000 = 17.3%
Year 2	(36300000-13310000)/(133100000-26620000) = 21.6%	(36300000-13310000)/133100000 = 17.3%
Year 3	(39930000-14641000)/(146410000-43923000) = 24.7%	(39930000-14641000)/146410000 = 17.3%
Year 4	(43923000-16105100)/(161051000-64420400) = 28.8%	(43923000-16105100)/161051000 = 17.3%