Question

Sally Omar is the manager of the office products division of Runner Enterprises. In this position, her annual bonus is based on an appraisal of return on investment (ROI) measured as Division income ÷ End-of-year division assets (net of accumulated depreciation).

Currently, Sally is considering investing $36,808,000 in modernization of the division plant in Tennessee. She estimates that the project will generate cash savings of $6,032,000 per year for 8 years. The plant improvements will be depreciated over 8 years ($36,808,000 ÷ 8 years = $4,601,000). Thus, the annual effect on income will be $1,431,000 ($6,032,000 - $4,601,000).

Calculate the ROI of the project each year over its 8-year life. (Calculate ROI as effect on income divided by end-of-year book value. Note that the value of ROI is not defined at the end of year 8 when book value is zero.) (Round answers to 2 decimal places, e.g. 15.25%.)

YEAR	ROI
1
2
3
4
5
6
7

Answer 1

Year	End of year value	Effect on Net Income	ROI
0	$        36,808,000
1	$        32,207,000	$                  1,431,000	4.44%
2	$        27,606,000	$                  1,431,000	5.18%
3	$        23,005,000	$                  1,431,000	6.22%
4	$        18,404,000	$                  1,431,000	7.78%
5	$        13,803,000	$                  1,431,000	10.37%
6	$          9,202,000	$                  1,431,000	15.55%
7	$          4,601,000	$                  1,431,000	31.10%