Question

Rochelle Company has just purchased a milling machine at a cost of $200,000. The machine is expected to generate operating income of $18,000 per year during its 10-year useful life. Rochelle uses the straight-line method of depreciation with a zero terminal disposal value.

Calculate ROI in the following situations:

a.First year using gross book value as the investment base.

b.Sixth year using gross book value as the investment base.

c.First year using net book value at the end of the year as the investment base.

d.Sixth year using net book value at the beginning of the year as the investment base.

Answer 1

Solution a:

Gross book value = $200,000

Operating income = $18,000

ROI for first year using gross book value as the investment base = $18,000 / $200,000 = 9%

Solution b:

Gross book value in year 6 = $200,000

Operating income = $18,000

ROI for sixth year using gross book value as the investment base = $18,000 / $200,000 = 9%

Solution c:

Annual depreciation = $200,000/10 = $20,000

Net Book value at the end of year 1 = $200,000 - $20,000 = $180,000

ROI for First year using net book value at the end of the year as the investment base = $18,000 / $180,000 = 10%

Solution d:

Annual depreciation = $200,000/10 = $20,000

Accumulated depreciation at the beginning of year 6 = $20,000 * 5 = $100,000

Net Book value at the beginning of year 6 = $200,000 - $100,000 = $100,000

ROI for Sixth year using net book value at the beginning of the year as the investment base = $18,000 / $100,000 = 18%