Impact of New Asset on Performance Measures
Ocean Division currently earns $780,000 and has divisional assets of $3.9 million. The division manager is considering the acquisition of a new asset that will add to profit. The investment has a cost of $675,000 and will have a yearly cash flow of $168,000. The asset will be depreciated using the straight line method over a six year life and is expected to have no salvage value. Divisional performance is measured using ROI with beginning of year net book values in the denominator. The company’s cost of capital is 15 percent. Ignore taxes.
Required
a. What is the divisional ROI before acquisition of the new asset?
b. What is the divisional ROI in the first year after acquisition of the new asset?