The Caribbean Division of Mega-Entertainment Corporation just started operations
ID: 463867 • Letter: T
Question
The Caribbean Division of Mega-Entertainment Corporation just started operations. It purchased depreciable assets costing $25 million and having a four-year expected life, after which the assets can be salvaged for $5 million. In addition, the division has $25 million in assets that are not depreciable. After four years, the division will have $25 million available from these non-depreciable assets. This means that the division has invested $50 million in assets with a salvage value of $30 million. Annual depreciation is $5 million. Annual operating cash flows are $17.5 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:
Depreciation is as follows:
Note that "accumulated" depriciation is 10 percent of the gross book value of depreciable asets after on 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).
End of Year Replacement Cost Annual Cash Flow 1 $50,000,000 x 1.1 = $55,000,000 $17,500,000 x 1.1 = $19,250,000 2 $55,000,000 x 1.1 = $60,500,000 $19,250,000 x 1.1 =$21,175,000 3 etc. etc. 4Explanation / Answer
ROI using Historical Cost Historical cost ROI Net Book Value % ROI Gross Book Value % Year1 42.8 38.5 Year2 52.9 42.4 Year3 66.6 46.6 Year4 85.4 51.2 Working notes Year Gross Book value Depreciation Net Book Value Return 1 50000000 5000000 45000000 19250000 2 50000000 10000000 40000000 21175000 3 50000000 15000000 35000000 23292500 4 50000000 20000000 30000000 25621750 *ROI = Return/Assets *100 Answer ROI using Current cost Historical cost ROI Net Book Value % ROI Gross Book Value % Year1 38.89 35.00 Year2 38.89 35.00 Year3 38.89 35.00 Year4 38.89 35.00 Working notes Year Gross Book value Depreciation Net Book Value Return 1 55000000 5500000 49500000 19250000 2 60500000 6050000 54450000 21175000 3 66550000 6655000 59895000 23292500 4 73205000 7320500 65884500 25621750 *ROI = Return/Assets *100
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