Worked example 1

A retailer considers closing its online division. Accounts show: stores ROCE 18%, online ROCE 4%, online revenue growing 25% but operating loss $2 m. Discuss how accounting data informs the decision.

Show solution outline

For closure: Low ROCE (4%) destroys value vs stores (18%); operating loss drains group profit; resources could fund store refurbishment with higher return.

Against closure: Revenue growth 25% suggests future potential not captured in historic loss; closure costs (redundancies, contracts); segment data may omit shared costs fairly.

Strategic synthesis: Use contribution analysis (5.4.2) for incremental online costs, NPV of continuing vs closing (10.3), plus qualitative brand presence online. Accounting starts the debate — does not alone decide.

Worked example 2

Innovate PLC is choosing between two strategic growth options. Its cost of capital is 10%. Using the Net Present Value (NPV) method, advise which option is financially preferable.

Option A: Market Development

Initial Investment: $5,000,000$
Forecasted Net Cash Flows: Y1: $1.5m, Y2:$ 2.0m, Y3: $2.5m, Y4:$ 2.5m

Option B: Product Development

Initial Investment: $6,000,000$
Forecasted Net Cash Flows: Y1: $1.0m, Y2:$ 2.5m, Y3: $3.5m, Y4:$ 3.0m

(Discount factors at 10%: Y1=0.909, Y2=0.826, Y3=0.751, Y4=0.683)

Show solution outline

The decision will be based on which project yields a higher positive NPV, as this indicates greater value creation for the business.

Formula: NPV = Sum of Present Values of Cash Inflows - Initial Investment

Step 1: Calculate the Present Value (PV) of cash flows for Option A

Year 1: $1,500,000 * 0.909 =$ 1,363,500
Year 2: $2,000,000 * 0.826 =$ 1,652,000
Year 3: $2,500,000 * 0.751 =$ 1,877,500
Year 4: $2,500,000 * 0.683 =$ 1,707,500
Total PV (Option A): $1,363,500 +$ 1,652,000 + $1,877,500 +$ 1,707,500 = $6,600,500$

Step 2: Calculate NPV for Option A

NPV (A) = $6,600,500 -$ 5,000,000 = ** $1,600,500**$

Step 3: Calculate the Present Value (PV) of cash flows for Option B

Year 1: $1,000,000 * 0.909 =$ 909,000
Year 2: $2,500,000 * 0.826 =$ 2,065,000
Year 3: $3,500,000 * 0.751 =$ 2,628,500
Year 4: $3,000,000 * 0.683 =$ 2,049,000
Total PV (Option B): $909,000 +$ 2,065,000 + $2,628,500 +$ 2,049,000 = $7,651,500$

Step 4: Calculate NPV for Option B

NPV (B) = $7,651,500 -$ 6,000,000 = ** $1,651,500**$

Conclusion: Both options are financially viable as they have positive NPVs. However, Option B (Product Development) is the financially preferable choice as its NPV of $1,651,500 is higher than Option A's NPV of $1,600,500. This suggests it will add more value to the business. The strategic decision should also consider the higher risk and investment associated with product development compared to market development.

The use of accounting data to enable strategic decision-making — practice questions

Worked example 1

Worked example 2