Problem 14-38 Evaluate Trade-Offs in Return Measurement (LO 14-2) Oscar Clemente
ID: 2466934 • Letter: P
Question
Problem 14-38 Evaluate Trade-Offs in Return Measurement (LO 14-2) 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:
Sales revenue $ 16,000,000
Operating costs:
Variable 2,000,000
Fixed (all cash) 7,500,000
Depreciation:
New equipment 1,500,000
Other 1,250,000
Division operating profit $ 3,750,000
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 depreciated for accounting purposes over a 3-year life. Depreciation would be net of the $500,000 salvage value of the new machine. The new equipment meets Pitt's 20 percent cost of capital criterion. If Oscar purchases the new machine, it must be installed prior to the end of the year. For practical purposes, though, Oscar can ignore depreciation on the new machine because it will not go into operation until the start of the next year. 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 ROI. The return includes any losses on disposal of equipment. Investment is computed based on the end-of-year balance of assets, net book value. Ignore taxes. Oscar Clemente is still assessing the problem of whether to acquire LSI’s assembly machine. He learns that the new machine could be acquired next year, but if he waits until then, it will cost 15 percent more. The salvage value would still be $500,000. Required:
Calculate ROI for the coming year assuming that the new equipment is bought at the beginning of the year. (Round your answer to 1 decimal place.)
*****Please show all math thank you
Explanation / Answer
Answer Investment in New Machine 6500000 Increase value@ 15% 975000 New Value of machine 7475000 Old Investments 4000000-1250000 2750000 Total Investments 10225000 New Income Statement Sales =16000000*10%+16000000 17600000 Variable Cost =2000000*10%+2000000 2200000 Fixed Cost = 7500000-7500000*5% 7125000 Depreciation new machine (7475000-500000)/3 2325000 Depreication other 1250000 Loss on disposal of old machine 5000000-1500000 3500000 Net Income 1200000 ROI 1200000/10225000*100 11.7%