Question

Sally Omar is the manager of the office products division of Hiroole 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 $40,992,000 in modernization of the division plant in Tennessee. She estimates that the project will generate cash savings of $6,784,000 per year for 8 years. The plant improvements will be depreciated over 8 years ($40,992,000 ÷ 8 years = $5,124,000). Thus, the annual effect on income will be $1,660,000 ($6,784,000 - $5,124,000).

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.)

Answer 1

ROI = Effect on Income/End of year book value

Year	Opening Book Value	Depreciation	End of year book value (1)	Effect on Income (2)	ROI (2/1)
1	40,992,000	5,124,000	35,868,000	1,660,000	4.63%
2	35,868,000	5,124,000	30,774,000	1,660,000	5.39%
3	30,774,000	5,124,000	25,620,000	1,660,000	6.48%
4	25,620,000	5,124,000	20,496,000	1,660,000	8.10%
5	20,496,000	5,124,000	15,372,000	1,660,000	10.80%
6	15,372,000	5,124,000	10,248,000	1,660,000	16.20%
7	10,248,000	5,124,000	5,124,000	1,660,000	32.40%
8	5,124,000	5,124,000	0	1,660,000	Not defined