Concept explainers
Equipment Replacement and Performance Measures
Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer of biotech products. Forbes Division, which has $4 million in assets, manufactures a special testing device. At the beginning of the current year, Forbes invested $5 million in automated equipment for test machine assembly. The division’s expected income statement at the beginning of the year was as follows:
A sales representative from LSI Machine Company approached Oscar in October. LSI has for $6.5 million a new assembly machine that offers significant improvements over the equipment Oscar bought at the beginning of the year. The new equipment would expand division output by 10 percent while reducing cash fixed costs by 5 percent. It would be
The old machine, which has no salvage value, must be disposed of to make room for the new machine.
Pitt has a performance evaluation and bonus plan based on
Required
- a. What is Forbes Division’s ROI if Oscar docs not acquire the new machine?
- b. What is Forbes Division's ROI this year if Oscar acquires the new machine?
- c. If Oscar acquires the new machine and it operates according to specifications, what ROI is expected for next year?
a.
Calculate the division F’s ROI if Company O does not acquire the new machine
Answer to Problem 46P
The return on investment is 60% when Company O does not acquire the new machine.
Explanation of Solution
Return on investment:
Return on investment is the amount of total profit earned by a division with its assets. The return on investment is used to check the efficiency of the unit. It shows the efficiency of the unit to utilize its assets to generate the profit.
Calculate the ROI if Company O does not acquire the new machine:
Thus, the return on investment is 60% when Company O does not acquire the new machine.
Working note 1:
Calculate the net asset value:
Particulars | Amount |
Opening asset value | $4,000,000 |
Add: addition in the year | $5,000,000 |
Total asset value | $9,000,000 |
Less: depreciation on new equipment | $1,500,000 |
Less: depreciation on others | $1,250,000 |
Net asset value | $6,250,000 |
Table: (1)
b.
Calculate the division F’s ROI if Company O acquires the new machine
Answer to Problem 46P
The return on investment is 2.7% when Company O does not acquire the new machine.
Explanation of Solution
Divisional ROI:
Divisional ROI is the return on investment for a division of a business. It is calculated by dividing the operating profit of the division from the divisional assets.
Calculate the ROI if Company O acquires the new machine:
Thus, the return on investment is 2.7% when Company O does not acquire the new machine.
Working note 2:
Calculate the net asset value:
Particulars | Amount |
Opening asset value | $4,000,000 |
Add: improvement in the asset | $6,500,000 |
Total asset value | $10,500,000 |
Less: depreciation on others | $1,250,000 |
Net asset value | $9,250,000 |
Table: (2)
Working note 3:
Calculate the after-tax divisional profit:
Particulars | Amount |
Operating profit | $3,750,000 |
Less: loss on old equipment | $5,000,000 |
Add: saving in the depreciation of old equipment | $1,500,000 |
Net operating profit | $250,000 |
Table: (3)
c.
Calculate the ROI if the company acquires a new machine and operates it according to specifications.
Answer to Problem 46P
The return on investment is 83.75% if the company acquires a new machine and operates it according to specifications.
Explanation of Solution
Divisional income:
A business may be operating in various departments or units. Each unit has its own cost and profit structure. The profit of a specific unit is called divisional income. It is calculated by deducting the divisional expense from the divisional profit.
Calculate the ROI if Company O acquires the new machine:
Thus, the return on investment is 83.75% when Company O does not acquire the new machine.
Working note 4:
Calculate the divisional operating income:
Particulars |
Amount (a) |
% change (b) |
Net amount |
Sales | $16,000,000 | +10% | $17,600,000 |
Operating costs: | |||
Variable | $2,000,000 | +10% | $2,200,000 |
Fixed | $7,500,000 | -5% | $7,125,000 |
Deprecation: | |||
New equipment(6) | $1,500,000 | $2,000,000 | |
Others | $1,250,000 | $1,250,000 | |
Divisional operating profit | $5,025,000 |
Table: (4)
Working note 5:
Calculate the net asset value:
Particulars | Amount |
Opening asset value | $4,000,000 |
Add: improvement in the asset | $6,500,000 |
Total asset value | $10,500,000 |
Less: depreciation on others | $2,500,000 |
Less: depreciation on improved assets(6) | $2,000,000 |
Net asset value | $6,000,000 |
Table: (5)
Working note 6:
Calculate the depreciation on new equipment:
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Chapter 14 Solutions
Fundamentals Of Cost Accounting (6th Edition)
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