Comment on the viability of B’s proposal in the light of the foregoing.

A group consists of three operating divisions. Divisions A and B are long established and

 

situated at the main site using old plant and equipment. The two divisions make much use

of shared facilities. Division C is recently established at an independent site using its own

new equipment. The three divisions are treated as profit centres with performance assessed

on the basis of ‘divisional return on capital employed’, calculated as follows:

In the case of assets or head office costs not clearly attributable to any one division, the

relevant figures are apportioned between divisions on a turnover basis. The divisions are

currently generating a ROCE of about 10 per cent each.

In order to improve profitability a new system of investment appraisal has been introduced

requiring that all new investments should be able to show an independent ROCE

(judged on the above criteria) of at least 15 per cent.

Division B proposes a new project, detailed as follows:

Cost of new dedicated equipment                £75,000 (assumed to have a 5-year life)

Working capital                                         £75,000

Share of old equipment                             £20,000 (assumed to have an indefinite life)

Life of project                                            5 years

Sales per year                        140 units at £390 each

Variable costs                       £150 per unit

Fixed costs per year                £17,000 including depreciation

Requirements

(a) Comment on the present methods of performance appraisal and investment analysis.

(b) Comment on the viability of B’s proposal in the light of the foregoing.

 

 

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