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
(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.