ExpertMedium10 marksStructured
ACCA · Question 38 · Performance Measurement
SECTION B - MULTI-TASK QUESTION 3 (PERFORMANCE MEASUREMENT)
A global logistics provider operates an autonomous European division.
Financial data for the year:
- Revenue: $5,000,000
- Controllable operating profit: $750,000
- Average divisional net assets: $3,000,000
- Cost of capital: 15%
Provide the following 5 answers (each worth 2 marks):
- Calculate the Return on Investment (ROI) as a percentage.
- Calculate the Residual Income (RI).
- Calculate the Asset Turnover ratio (to two decimal places).
- Calculate the Operating Profit Margin as a percentage.
- If the division invests in a new project yielding an 18% return, state whether this will INCREASE or DECREASE the division's current ROI.
SECTION B - MULTI-TASK QUESTION 3 (PERFORMANCE MEASUREMENT)
A global logistics provider operates an autonomous European division.
Financial data for the year:
- Revenue: $5,000,000
- Controllable operating profit: $750,000
- Average divisional net assets: $3,000,000
- Cost of capital: 15%
Provide the following 5 answers (each worth 2 marks):
- Calculate the Return on Investment (ROI) as a percentage.
- Calculate the Residual Income (RI).
- Calculate the Asset Turnover ratio (to two decimal places).
- Calculate the Operating Profit Margin as a percentage.
- If the division invests in a new project yielding an 18% return, state whether this will INCREASE or DECREASE the division's current ROI.
How to approach this question
Use standard financial performance formulas. ROI = Profit / Net Assets. RI = Profit - (Net Assets * Cost of Capital). Asset Turnover = Revenue / Net Assets. Margin = Profit / Revenue.
Full Answer
1. ROI = ($750,000 / $3,000,000) × 100 = 25%.
2. Imputed interest = 15% × $3,000,000 = $450,000. RI = $750,000 - $450,000 = $300,000.
3. Asset Turnover = Revenue / Net Assets = $5,000,000 / $3,000,000 = 1.666... = 1.67.
4. Operating Profit Margin = ($750,000 / $5,000,000) × 100 = 15%.
5. The current ROI is 25%. A new project yielding 18% is lower than the current average, so adding it will DECREASE the overall divisional ROI (even though it exceeds the 15% cost of capital).
Common mistakes
Stating the new project will INCREASE ROI because 18% > 15% cost of capital. It increases RI, but decreases ROI.
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