Question

Oscar Clement is the manager of Forbes Division of Princ, a manufacturer of titech products. Forbes Division, which has on inst, maractures aspecting device the beginyer Forbes invested to in automated equipment for best machine assembly. The division's expected income statement at the beginning of the year was as follows: Operating Deprecation Oth Doping 10000 7400 000 1.450.000 DO 3301500 A sales representative from LSI Machine Company approached Oscar in Odober LSI as for $5.65 mon new assembly machine that others can improvements over the ment Oscar bought the begin of the year. The new equipment would expand division up by 10 percent while reducing cash feed costs by percent would be depreciated for accounting purposes over a year life. Depreciation would be note 500.000 salvage value of the new machine. The new equipment met Pes 20 percent cost of capital criterion Oscar purchases the new machine must be led prior to the end of the year. For practical purposes, though car can ignore depreciation on the new machine because it will not go into operation the start of the next year. The old machine, which has no savage value must be disposed of to make room for the new machine Pleasa performance evaluation and bonus pion based on ROI. The retum includes anyone on osa olement went is computed based on the end of year balance of assets, netbookvaleromete Required .. What is Forbes Division's ROI Oscar does not acquire the new machine? (Teter your answer as a percentage rom decimale 32:11 b. What is Forbes Division's this year Oscaroquires the new machine for your answer as a percentage rounded to decimal place ... 323)

Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer of biotech products. Forbes Division, which has $4.05 million in assets, manufactures a special testing device. At the beginning of the current year, Forbes invested $5.12 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	$	16,060,000
Operating costs
Variable		2,100,000
Fixed (all cash)		7,660,000
Depreciation
New equipment		1,560,000
Other		1,330,000
Division operating profit	$	3,410,000

A sales representative from LSI Machine Company approached Oscar in October. LSI has for $4.83 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 three-year life. Depreciation would be net of the $519,000 salvage value of the new machine. The new equipment meets Pitt's 12 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 residual income. Pitt uses a cost of capital of 12 percent in computing residual income. Income 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 residual income if Oscar does not acquire the new machine? (Negative amount should be indicated by a minus sign. Enter your answer in thousands of dollars. Round your final answers to nearest whole dollar.)

b. What is Forbes Division’s residual income this year if Oscar acquires the new machine? (Negative amount should be indicated by a minus sign. Enter your answer in thousands of dollars. Round your final answers to nearest whole dollar.)

c. If Oscar acquires the new machine and operates it according to specifications, what residual income is expected for next year? (Negative amount should be indicated by a minus sign. Enter your answer in thousands of dollars. Round your final answers to nearest whole dollar.)

Answer 1

Sales revenue		16060000
Operating costs
Variable	2100000
Fixed	7660000	9760000
Depreciation
New	1560000
Other	1330000	2890000
Operating profit		3410000

a.

Operating income		3410000
Assets		4050000
Depreciation		1330000
Investment		5120000
Depreciation		1560000
Investment		6280000
Return = 12%
Operating profit		3410000
Capital charge		753600
Residual income		2656400

b.

Cost of getting rid of old machine
Cost		5120000
Depreciation		1560000
Book value		3560000
Salvage value		0
Loss on sale		3560000
New operating income and investment
Operating income		3410000
Loss on sale		3560000
New operating income		-150000
Assets		4050000
Depreciation		1330000
Investment		4830000
Current year depreciation		0
Net investment		7550000
Return =12%
Operating profit		-150000
Capital charge		906000
Residual income		-1056000

c.

Revenue increase	10%
Variable cost increase	10%
Fixed cost decrease	5%
Revenue	17666000
VC	2310000
FC	7277000
Total cost	9587000
Current asset depreciation	1330000
New asset depreciation	1437000	(4830000-519000)/3
Total	2767000
Revenue	17666000
Total cost	9587000
Total depreciation	2767000
Operating income	5312000
Assets	4050000
Depreciation	2660000	1330000*2
New investment	4830000
Depreciaiotn	1437000
Net investment	4783000
Return =12%
Operating income	5312000
Capital charge	573960
Residual income	4738040