First, we need to calculate the ROI if the asset is purchased:
Yearly profit from new asset = $1,469,000
Depreciation expense per year = $5,508,000 / 5 = $1,101,600
Net income from new asset = $1,469,000 - $1,101,600 = $367,400
Total divisional profit with new asset = $2.86 million + $367,400 = $3,227,400
Total divisional assets with new asset = $26 million + $5,508,000 = $31,508,000
ROI with purchased asset = ($3,227,400 / $31,508,000) x 100% = 10.2%
Now let's calculate the ROI if the asset is leased:
Yearly profit from lease = $1,180,000
Total divisional profit with leased asset = $2.86 million + $1,180,000 = $4,040,000
Total divisional assets with leased asset = $26 million
ROI with leased asset = ($4,040,000 / $26 million) x 100% = 15.5%
Therefore, the divisional ROI if the asset is leased is 15.5%.
The Plastics Division of Minock Manufacturing currently earns $2.86 million and has divisional assets of $26 million. The division manager is considering the acquisition of a new asset that will add to profit. The investment has a cost of $5,508,000 and will have a yearly cash flow of $1,469,000. The asset will be depreciated using the straight-line method over a five-year life and is expected to have no salvage value. Divisional performance is measured using ROI with beginning-of-year net book values in the denominator. The company's cost of capital is 7 percent. Ignore taxes. The division manager learns that there is an option to lease the asset on a year-toyear lease for $1,180,000 per year. All depreciation and other tax benefits would accrue to the lessor. Required: What is the divisional ROI if the asset is leased? Note: Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).
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