Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer o

Question

Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer of biotech products. Forbes Division, which has $4.7 million in assets, manufactures a special testing device. At the beginning of the current year, Forbes invested $5.7 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 Operating costs $ 19,500,000 Variable Fixed (all cash) 2,700,000 8,200,000 Depreciation New equipment 1,570,000 1,950,000 $ 5,080,000 Other Division operating profit A sales representative from LSI Machine Company approached Oscar in October. LSI has for $7.2 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 10.7 percent while reducing cash fixed costs by 5.7 percent. It would be depreciated for accounting purposes over a three-year life. Depreciation would be net of the $570,000 salvage value of the new machine. The new equipment meets Pitt's 20.7 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.

Explanation / Answer

Answer)

Although the machinery not started its operations yet its depreciation must be accounted as it is ready for use:

ROI:

divisional operating profit/(variable+ fixed operatingoperat+depreciation(old equipment and new equipment))

=[$5080000/$(2700000+8200000+1570000+1950000)]×100

=35.23%

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