Question

Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer of biotech products. Forbes Division, which has $4.5 million in assets, manufactures a special testing device. At the beginning of the current year, Forbes invested $3 million in automated equipment for test machine assembly. The division's expected income statement at the beginning of the year was as follows: $ 15,000,000 1,975.000 7.100.000 Sales revenue Operating costs Variable Fixed (all cash) Depreciation New equipment Other Division operating profit 1,490,000 1,200,000 $ 3,235.000 A sales representative from LSI Machine Company approached Oscar in October. LSI has for $7.5 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 4-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 retum includes any losses on disposal of equipment. Investment is computed based on the end-of-year balance of assets, net book value. Ignore taxes. Required: a. What is Forbes Division's ROI if Oscar does not acquire the new machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).) ROI b. What is Forbes Division's ROI this year Oscar acquires the new machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).) ROI c. If Oscar acquires the new machine and it operates according to specifications, what ROI is expected for next year? (Enter your answer as a percentage rounded to 1 decimal place (I.e., 32.1).) ROI

Answer 1

(a)

ROI

67.3%

Explanations :-

ROI
Net Income	$3,235,000
÷ Total Assets	$4,810,000
Return on Investment	67.3%
Total Assets
Beginning Assets	$4,500,000
Add: Beginning Investment	$3,000,000
Less: Total Depreciation	$2,690,000
	$ 4,810,000

(b)

ROI

16.0%

Explanations :-

ROI
Net Income	$1,725,000
÷ Total Assets	$10,800,000
Return on Investment	16.0%
Net Income
Division operating profit	$3,235,000
Less: Loss on sale of equipment	$1,510,000
($3000000 - $1490000)
Net Income	$1,725,000
Total Assets
Beginning Assets	$4,500,000
Less:Depreciation	$1,200,000
Add: New Equipment	$7,500,000
	$ 10,800,000

(c)

ROI

59.0%

Explanations :-

ROI
Net Income	$4,632,500
÷ Total Assets	$7,850,000
Return on Investment	59.0%
Net Income
Sales Revenue	$16,500,000	(up 10%)
Cost:
Variable	$2,172,500	(up 10%)
Fixed	$6,745,000	(down 5%)
Depreciation:
Equipment ($75m - $5m)/4 years	$1,750,000
Other	$1,200,000
Net Income	$4,632,500
Total Assets
Beginning Assets	$4,500,000
Less: Depreciation ($1200000*2)	$2,400,000
Add: New Equipment	$7,500,000
Less: Depreciation on new equipment	$1,750,000
	$    7,850,000