Question

Shaft Mining Ltd is a mining contractor with ten autonomous divisions operating in various copper mines in Copperbelt and North-Western provinces of Zambia. The cost of capital for the group is 12% per annum and is currently earning 15% on its capital employed.

In the ROCE calculation, return is equated with net profit and capital employed figure at the beginning of the financial year. All fixed assets are depreciated on a straight-line basis. Investments in new projects include incremental working capital. Projects sold or withdrawn from operation are treated as consisting of fixed assets only.

If no new expenditure transactions take place the position of four of the divisions would be:

Division	Capital employed as at 1 January 2019	Net profit	Budgeted for 2019 Sales
	K’000	K’000	K’000
Kitwe	3,200	800	8,000
Solwezi	4,500	1,500	14,000
Chingola	2,800	840	7,000
Mufulira	2,000	260	2,000

The following transactions were proposed:

Kitwe Division          

Investment of K1,000,000 to yield sales of K1,500,000 per annum and net profit of K200,000 per annum.

Solwezi Division        

Sale for K750,000 of a projected that is budgeted to yield a net profit of K150,000 in 2019. The original equipment cost K6,000,000 seven years ago with an expected life of eight years.

Chingola Division      

(a) sale of product line at book value. The original equipment cost K600,000 two years ago      with an expected life of three year. This line is budgeted to yield a net of K200,000 in 2019; combined with

(b) replacement   of (a) above by investing K1,000,000 in a new product to yield K300,000 per annum.

Mufulira Division      

Investment of K800,000 in a project to yield sales of K360,000 per annum and a net profit of K112,000 per annum.

(Note. In connection with each of the above transactions, you are to assume that the sale and/or investment would be completed by 1 January 2019 so as to be included in the relevant ROCE calculations for the year 2019. Ignore taxation and inflation considerations and assume that actual results are as budgeted.)

Required

A. On the assumption that each transaction goes ahead:

(i) Calculate the new ROCE for each division for the year ending 31 December 2019.                                               

(ii)Identify those divisional managers whose bonuses will be higher if they receive annual bonuses directly related to the level of their respective ROCE.                                                                                                                                                        

(iii) State, in respect of each division, whether the group’s interest will be favourably or adversely affected by the proposed transactions. Explain briefly why in each case.                                                                                                               

B. Identify, with brief reasons, which proposals the group would approve if its new capital expenditure were limited to K2,000,000 for the four divisions.                                                                                                                                                          

C. Compare the old results Kitwe Division and Mufulira Division, and briefly advise the divisional manager of Mufulira Division how he might improve his performance based on the data concerning Kitwe Division.     

D. Comment briefly on how the new project for Mufulira Division fits in with the advice given in (c) above.

E. Calculate the lowest price at which the equipment should be sold by Solwezi Division if the transaction proposed is to break even financially for the group.

Answer 1

All the Amount in '000

A. (i) ROCE= Net Profit / Capital Employed*100

Kitwe Division = (800+200)/(3200+1000)*100 = 23.81%

Solwezi Division = (1500+150)/ 4500*100 = 36.67%

Chingola Division = (840+200)/(2000+1000)*100 =34.67%

Mufulira Division = (260+112)/(2000+800)*100 = 13.29%

A. (ii) Solwezi divisional managers bonuses will be higher if they receive annual bonuses directly related to the level of their respective ROCE. Solwezi Division ROCE at the Beginning was 33.33% [1500/4500*100] which is at the end increased to 36.67.

After Solwezi division ,Chingola division will earn higher  bonus as the proposed ROCE is 34.67% which was at the Beginning was 30% [840/2800*100]