Question

Your uncle is working in a company managing their investment center. You approach him with the sales of a large piece of equipment that can help the company save money in the end. Your uncle explains to you that they can’t purchase the equipment because they don’t want their ROI to decrease in value. What will be your persuasive argument to help them see more possibilities?

Answer 1

• Return on investment equals = profit before interest and tax/capital employed
• The uncle is correct that invest in new investment will result in a decrease in ROI. This is because new assets will increase the amount of capital employed. However, the uncle is currently presenting what we known as the dysfunctional behavior in management accounting. It is not wise to hold old assets and abandon the need to replace new assets just because to maintain the ROI figure.
• Thus, to be clearer on this investment decision, a net present value method should be used. This can shows whether the investment in the new equipment is worthwhile. Similarly, you should persuade your uncle that new equipment may yield higher profit before interest and tax and this may also increase ROI (instead relying on dysfunctional behaviors of not replacing old asset)