Early in January 2010, Tellco, Inc., acquired a new machine and incurred $100,00

Question

Early in January 2010, Tellco, Inc., acquired a new machine and incurred $100,000 of interest, installation, andoverhead costs that should have been capitalized but were expensed. The company earned ne operating income of $1,000,000 on average total assests of $8,000,000 for 2010. Assume that the total cost of the new machine will depreciated over 10 years using the straight-line method.

Question:
Assuming that the $100,000 is capitalized, what will be the effect on ROI for 2011 and subsequent years, compared to expensing the interest, installation, and overhead costs in 2010.

Thanks so much for the help,

Explanation / Answer

Hey, Return on assets = Net Income/Total Assets Return on assets = 1,000,000/8,000,000 = .125 or 12.5% That being said, if you bought $100,000 worth of assets you would be expecting a return of $100,000 * .125 = $12,500 a year return on your assets. As a result, if you were to capitalize the assets, you would of gained $12,500 a year but since you expensed it, you lost 87,500 the first year (100,000-12,500) and gained 12,500 each year after that.

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