Question

The Ste. Marie Division of Pacific Media Corporation just started operations. It purchased depreciable assets costing $39 million and having a four-year expected life, after which the assets can be salvaged for $7.8 million. In addition, the division has $39 million in assets that are not depreciable. After four years, the division will have $39 million available from these nondepreciable assets. This means that the division has invested $78 million in assets with a salvage value of $46.8 million. Annual depreciation is $7.8 million. Annual operating cash flows are $20 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

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

Answer 1

Solution:

Computation of annual Operating Income
Particulars	Amount (In million)
Annual operating cash flows	$20.00
Less: Depreciation	$7.80
Annual operating income	$12.20

Computation of Gross book value and net book value of assets at the end of each year
Particulars	Year 0	Year 1	Year 2	Year 3	Year 4
Gross Book value of Assets	$78.00	$78.00	$78.00	$78.00	$78.00
Less: Accumulated depreciation	$0.00	$7.80	$15.60	$23.40	$31.20
Net Book Value	$78.00	$70.20	$62.40	$54.60	$46.80

Computation of ROI
Particulars	Year 1	Year 2	Year 3	Year 4
Using Gross Book Value
Net operarting income	$12.20	$12.20	$12.20	$12.20
Gross book value of asset at beginning	$78.00	$78.00	$78.00	$78.00
ROI (Net operating income / Gross assets book value)	15.64%	15.64%	15.64%	15.64%
Using Net Book Value
Net operarting income	$12.20	$12.20	$12.20	$12.20
Net book value of asset at beginning	$78.00	$70.20	$62.40	$54.60
ROI (Net operating income / Net assets book value)	15.64%	17.38%	19.55%	22.34%