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).
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%.
To calculate the divisional ROI if the asset is leased, we need to compare the return on investment with and without the lease option.
First, let's calculate the net profit of the division if the asset is purchased:
Net Profit = Yearly Cash Flow - Depreciation Expense
Depreciation Expense = Cost of Asset / Asset Life = $5,508,000 / 5 = $1,101,600
Net Profit = $1,469,000 - $1,101,600 = $367,400
Next, let's calculate the divisional ROI if the asset is purchased:
ROI (Return on Investment) = Net Profit / Divisional Assets
ROI = $367,400 / $26,000,000 = 0.0141
Now, let's calculate the divisional ROI if the asset is leased:
Net Profit = Yearly Cash Flow - Lease Payment
Net Profit = $1,469,000 - $1,180,000 = $289,000
ROI (with lease) = Net Profit (with lease) / Divisional Assets
ROI (with lease) = $289,000 / $26,000,000 = 0.0111
Therefore, the divisional ROI if the asset is leased is 1.1% (rounded to 1 decimal place).