- 10 Marks
Question
Dondo LTD is a manufacturing company based in Nsawam. The following data represents the budgeted performance of Dondo LTD for the year 2025:
| Amount (GH¢’000) | |
|---|---|
| Profit | 660 |
| Plant and equipment (net of depreciation) | 1,560 |
| Working capital | 750 |
Dondo LTD is considering undertaking the following separate one-off transactions:
- A cash discount of GH¢16,000 will be offered to its customers annually. This will, on average, reduce the trade receivables figure by GH¢60,000.
- An increase in average inventories by GH¢80,000 throughout the year. The increased inventory level is expected to increase sales, resulting in GH¢30,000 increased contribution per annum.
- At the beginning of the year, the company will buy a plant worth GH¢360,000. This is expected to reduce operating costs by GH¢105,000. The plant has a five-year useful life with nil residual value.
Required:
i) Compute the ROI for each of the one-off transactions above.
ii) Advise Dondo LTD on whether the above one-off transactions should be carried out.
Answer
Current Budgeted ROI:
ROI=660,000(1,560,000+750,000)×100=660,0002,310,000=28.57%\text{ROI} = \frac{660,000}{(1,560,000 + 750,000)} \times 100 = \frac{660,000}{2,310,000} = 28.57\%
Revised ROI Calculations for Each Transaction:
-
Cash Discount Impact:
- Revised Profit: 660,000−16,000=644,000660,000 – 16,000 = 644,000
- Revised Capital Employed: 2,310,000−60,000=2,250,0002,310,000 – 60,000 = 2,250,000
- Revised ROI:
644,0002,250,000×100=28.62%\frac{644,000}{2,250,000} \times 100 = 28.62\%
-
Inventory Increase Impact:
- Revised Profit: 660,000+30,000=690,000660,000 + 30,000 = 690,000
- Revised Capital Employed: 2,310,000+80,000=2,390,0002,310,000 + 80,000 = 2,390,000
- Revised ROI:
690,0002,390,000×100=28.87%\frac{690,000}{2,390,000} \times 100 = 28.87\%
-
Plant Acquisition Impact:
- Revised Profit: 660,000+105,000−72,000=693,000660,000 + 105,000 – 72,000 = 693,000
- Revised Capital Employed: 2,310,000+360,000−72,000=2,598,0002,310,000 + 360,000 – 72,000 = 2,598,000
- Revised ROI:
693,0002,598,000×100=26.67%\frac{693,000}{2,598,000} \times 100 = 26.67\%
Advice to Dondo LTD:
Dondo LTD should carry out transactions (i) and (ii) because both yield a higher ROI than the current budgeted ROI. Transaction (iii) should be reconsidered as it results in a lower ROI.
- Tags: Cost Control, Decision Making, Financial Performance, Investment Appraisal, ROI
- Level: Level 2
- Topic: Performance analysis
- Series: Nov 2024
- Uploader: Salamat Hamid