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ACCA Strategic Professional · Advanced Performance Management · Financial performance measurement

Dunmore Telecom is comparing two divisions. Division A has net assets of $10m, mostly old equipment with a net book value that is 80% depreciated, and earns operating profit of $2.0m. Division B has net assets of $10m, mostly new equipment, and earns the same operating profit of $2.0m. Which statement about using ROI to compare these divisions is correct?

ROI is based on net book value, so heavily depreciated assets understate the capital employed in an old-asset division and flatter its return. Comparing divisions with different asset ages using book-value ROI is therefore misleading, even if the calculated percentages look identical.

  1. AROI is identical and therefore the divisions perform equally well in every respect, since profit is the same
  2. BROI is distorted because Division A's asset base is understated by depreciation, so its ROI looks flattering relative to underlying economic performanceCorrect
  3. CROI is distorted because Division B's assets are valued at replacement cost, which lowers its ROI
  4. DROI cannot be used because profit is the same in both divisions

Explanation

Both show net assets of $10m, so ROI is 20% each on the data given. However, the question states Division A's equipment is 80% depreciated, so its net book value understates the cost of the assets it uses, and a comparison based on net book value flatters old-asset divisions. The mismatch in asset age limits the usefulness of the measure. Option C is wrong because the data uses book values, not replacement cost.

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