Problem:
(a) Explain the meaning of each of the under-noted measures which may be used for divisional performance measurement and investment decision-making. Discuss the advantages and problems associated with the use of each.
(i) Return on capital employed.
(ii) Residual income.
(iii) Discounted future earnings.
(b) Comment on the reasons..why the measures listed in (a) above may give conflicting investment decision responses when applied to the same set of data. Use the following to illustrate the conflicting responses which may arise:
Additional investment of £60 000 for a 6 year life with nil residual value.
Average net profit per year: £9000 (after depreciation).
Cost of capital: 14%.
Existing capital employed: £300 000 with
ROCE of 20%.