Question 6.S-TQ2: Calculate the return on capital employed (average investment...
Calculate the return on capital employed (average investment basis) for the following projects, and show which would be chosen if the target ROCE is 12 per cent and there is zero scrap value.
| Project A (£) | Project B (£) | Project C (£) | |
| Initial investment
Net cash inflows: |
10,000 | 15,000 | 20,000 |
| Year 1 | 5,000 | 5,000 | 10,000 |
| Year 2 | 5,000 | 5,000 | 8000 |
| Year 3 | 2,000 | 5,000 | 4000 |
| Year 4 | 1,000 | 10,000 | 2000 |
| Year 5 | 5,000 |
Project A
Average annual accounting profit = (13,000 – 10,000)/4 = £750
Average annual investment = 10,000/2 = £5,000
Return on capital employed = (750 × 100)/5,000 = 15%
Project B
Average annual accounting profit = (30,000 – 15,000)/5 = £3,000
Average annual investment = 15,000/2 = £7,500
Return on capital employed = (3,000 × 100)/7,500 = 40%
Project C
Average annual accounting profit = (24,000 – 20,000)/4 = £1,000
Average annual investment = 20,000/2 = £10,000
Return on capital employed = (1,000 × 100)/10,000 = 10%
| Project | ROCE (%) | Ranking |
| A | 15 | 2 |
| B | 40 | 1 |
| C | 10 | 3 |
If the target ROCE is 12 per cent, projects A and B will be accepted.