The Caribbean Division of Mega-Entertainment Corporation just started operations
ID: 2467474 • Letter: T
Question
The Caribbean Division of Mega-Entertainment Corporation just started operations. It purchased depreciable assets costing $40 million and having a four-year expected life, after which the assets can be salvaged for $8 million. In addition, the division has $40 million in assets that are not depreciable. After four years, the division will have $40 million available from these non-depreciable assets. This means that the division has invested $80 million in assets with a salvage value of $48 million. Annual depreciation is $8 million. Annual operating cash flows are $15 million. In computing ROI, this division uses end-of-year asset values in the denominator. Depreciation is computed on a straight-line basis, recognizing the salvage values noted. Ignore taxes. Assume that all cash flows increase 10 percent at the end of each year. This has the following effect on the assets' replacement cost and annual cash flows: End of Year Replacement Cost Annual Cash Flow 1 $ 80,000,000 × 1.1 = $ 88,000,000 $ 15,000,000 × 1.1 = $ 16,500,000 2 $ 88,000,000 × 1.1 = $ 96,800,000 $ 16,500,000 × 1.1 = $ 18,150,000 3 Etc. Etc. 4 Depreciation is as follows: Year For the Year "Accumulated" 1 $ 8,800,000 $ 8,800,000 (= 10% × $88,000,000) 2 9,680,000 19,360,000 (= 20% × 96,800,000) 3 10,648,000 31,944,000 4 11,712,800 46,851,200 Note that "accumulated" depreciation is 10 percent of the gross book value of depreciable assets after one year, 20 percent after two years, and so forth. Required:
(a) Compute ROI using historical cost, net book value and gross book value. (Do not round intermediate calculations. Round your answers to 1 decimal place.)
(b) Compute ROI using current cost, net book value and gross book value. (Do not round intermediate calculations. Round your answers to 1 decimal place.)
Explanation / Answer
Amount ($) Purchased depriciable assets 40,000,000 Expected life 4,000,000 Salvage value 8,000,000 Non-depreciable assets 40,000,000 Expected life 4,000,000 Salvage value 40,000,000 Annual Depreciation 8,000,000 Annual Operating Cash Flows 15,000,000 Year 1 2 3 4 Replacement Cost 88,000,000 96,800,000 106,480,000 117,128,000 Annual Cash Flow 16,500,000 18,150,000 19,965,000 21,961,500 Depreciation for the year 8,800,000 9,680,000 10,648,000 11,712,800 Year-end Accumulated Depreciation 8,800,000 19,360,000 31,944,000 46,851,200 Historical Cost 88,000,000 88,000,000 88,000,000 88,000,000 Net Book Value 79,200,000 68,640,000 56,056,000 41,148,800 Gross Book Value 88,000,000 88,000,000 88,000,000 88,000,000 ROI (Using Hsitorical Cost) 18.75 20.62 22.68 24.95 ROI (Using Current Cost) 18.75 18.75 18.75 18.75
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