ROI AND RI

KLM is a divisionalised organisation. Some of the divisions are in overseas countries. Divisional performance is assessed by the trend in the Return on Capital Employed (ROI) and the Residual Income (RI) generated by each division based on their year-end values. The following summary nancial information is available for Division K: Year ending 3lst August 2018 2017 2016 | 9000 000 000 | Revenue 9,130 8,410 8,200 | Cost of Sales 1,360 1,200 1,240 | Gross prot 7,770 7,130 6,960 Other operating costs 4,220 4,110 3,950 Operating prot 3,550 3,020 3,010 | Capital employed as at the year end 6,750 9,000 12,000 | KLM has a cost of capital of 12% per annum. The gures shown above for the capital employed are the net book values of the division's non- current assets. Other operating costs include depreciation. There have been no additions or disposals ot'non-current assets within Division K during the three year period. No additions or disposals are expected in 2019. Forthe year ending 31 August 2019 it is expected that the revenues and costs (excluding depreciation) Will be the same as those in 2018. You are required to a) Calculate for Division K the Retum on Investment ROI and Residual Income (RI) for: (i) 2013 (11) 2019 lOMai-ks b) The board of directors of KLM have identied what they believe is a protable project. The project would require a capital investment of 62,200,000. The annual details of the project are as follows: ' 6'000 ' Revenue 900 I Costs 120 Depreciation 550 Operating prot 230 Life of Asset Years 4 The new assets would be depreciated in the same way as all other assets at KLM. At the end of the project the new assets would have no resale value. The board of KLM have suggested that Division K should undertake the project but the manager of Division K is reluctant to do so. Calculate the forecast ROI and R1 for Division K for the year ending 31 August 2019 if the project is undertaken by Division K. (Assume that the project started on 1St September 2018). 15 Marks c) Discuss, using appropriate calculations based on the above scenario, why the use of ROI and RI as performance measures can cause incorrect capital investment decisions to be Wan}? other means of assessing the performance of the new investment 15 Marks