ivision of Pitt, Inc., a manufacturer of biotech products. Forbes Division, which has $4.08 million in assets, manufactures a special testing device. At the beginning of the current year, Forbes invested $5 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 $ 16,120,000 Operating costs Variable 2,100,000 Fixed (all cash) 7,560,000 Depreciation New equipment 1,570,000 Other 1,380,000 Division operating profit $ 3,510,000
Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer of biotech products. Forbes Division, which has $4.08 million in assets, manufactures a special testing device. At the beginning of the current year, Forbes invested $5 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 | $ | 16,120,000 | |
| Operating costs | |||
| Variable | 2,100,000 | ||
| Fixed (all cash) | 7,560,000 | ||
| Depreciation | |||
| New equipment | 1,570,000 | ||
| Other | 1,380,000 | ||
| Division operating profit | $ | 3,510,000 | |
A sales representative from LSI Machine Company approached Oscar in October. LSI has for $6.15 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
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?
b. What is Forbes Division’s residual income this year if Oscar acquires the new machine?
c. If Oscar acquires the new machine and operates it according to specifications, what residual income is expected for next year?
(Enter your answers in thousands of dollars. Negative amounts should be indicated by a minus sign. Round your answers to the nearest whole dollars)
| a. | Residual income | |
| b. | Residual income | |
| c. | Residual income |
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