Strathcona Paper rewards its managers based on the ROI of the assets they generate - the higher the reported ROI, the higher the bonus. The company uses the net book value (assets less accumulated depreciation) to value the asset employed in calculating the return on invested capital. The company's cost of capital is estimated at 12% and its tax rate is 35%.

The manager of the logistics division on occasion to replace a fleet of old trucks. The division's net profit is $ 7,000 after tax and the current investment base is valued at $ 50,000,000. These two items, regardless of any investment in new trucks in the next paragraph, are expected to remain at the same levels regardless of whether the old trucks are left as mentioned in the next paragraph.

The possible investment, should not replace the current fleet at book value is around $ 100,000, with new trucks costing around $ 50,000,000, net of the rebate for old trucks. The new trucks will result in an increase in the company's profit over that which would generate the retention of the old trucks (due to increased revenues and decreased operating costs) of approximately $ 16,000,000 per year. year. This amount of $ 16,000,000 does not take into account the depreciation of the trucks or the tax. If the new trucks were purchased, they had to depreciate, for accounting purposes on a straight-line basis. The lifespan of the trucks is estimated at 5 years with no salvage value.

WORK TO DO

1) What is the current return on invested capital (ROI)?

2) What is the return on invested capital (ROI) if the proposed project is accepted?

3) If the division manager was rewarded based on residual profit (also called residual profit or residual net profit) would he want to go ahead with this investment?

4) Considering that the ROI is the only indicator used in this case to reward the manager and that one of the criticisms made of the RCI is to focus on short-term action to the detriment of long-term performance, suggest ways or ways to encourage / motivate the manager to focus on the long term.