Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer o
ID: 2521384 • Letter: O
Question
Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer of biotech products. Forbes Division, which has $4.15 million in assets, manufactures a special testing device. At the beginning of the current year, Forbes invested $5.07 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 $ 16,130,000 Variable Fixed (all cash) 2,140,000 40,00 Depreciation New equipment 1,670,000 1,420,000 Other Division operating profit $ 3,360,000 A sales representative from LSI Machine Company approached Oscar in October. LSI has for $6.24 million a new assembly machine that offers significant improvements over the equipment Oscar bought at the beginning of the year. The nevw 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 $609,000 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.Explanation / Answer
a. Forbes residual income if the new machine is not acquired = Division operating profit - Cost of Capital
= 3,360,000 - ((4,150,000 + 5,070,000) x 12%) = $2,253,600
b. Forbes Residual Income if the new machine is acquired = Division operating profit - Cost of Capital
= 3,360,000 - (((4,150,000 + 5,070,000 + 6,240,000) x 12%) = $1,504,800
Explanation: There would be no additional revenue or reduction in cash fixed costs during the current year as though the new machine is installed in the current year, it does not go into operation until the start of the next year.
c. Annual Depreciation on the new machine = (6,240,000 - 609,000) / 3 = $1,877,000
Additional Revenue due to installation of the new machine = 16,130,000 x 10% = $1,613,000
Savings in cash fixed cost = 7,540,000 x 5% = $377,000
Depreciation of the Old Machine = $1,670,000
Total Increase in Division Operating Profit due to installation of the new machine = 1,613,000 + 377,000 + 1,670,000
= $3,660,000
Forbes Residual Income for the next year if the new machine is acquired = 3,360,000 +3,660,000 - 1,877,000 - (((4,150,000 + 6,240,000) x 12%) = $3,896,200
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.