Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer of biotech products. Forbes Division, which has $3.5 million in assets, manufactures a special testing device. At the beginning of the current year, Forbes invested $3.5 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 $ 15,600,000 Operating costs Variable 2,000,000 Fixed (all cash) 7,100,000 Depreciation New equipment 1,490,000 Other 1,200,000 Division operating profit $ 3,810,000 A sales representative from LSI Machine Company approached Oscar in October. LSI has for $7.6 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 4-year life. Depreciation would be net of the $600,000 salvage value of the new machine. The new equipment meets Pitt's 20 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 ROI. The return 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 ROI if Oscar does not acquire the new machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).) b. What is Forbes Division's ROI this year if Oscar acquires the new machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).) c. If Oscar acquires the new machine and it operates according to specifications, what ROI is expected for next year? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).)
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Problem 14-46 (Algo) Equipment Replacement and Performance Measures (LO 14-2)
Oscar Clemente is the manager of Forbes Division of Pitt, Inc., a manufacturer of biotech products. Forbes Division, which has $3.5 million in assets, manufactures a special testing device. At the beginning of the current year, Forbes invested $3.5 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 | $ | 15,600,000 | |
| Operating costs | |||
| Variable | 2,000,000 | ||
| Fixed (all cash) | 7,100,000 | ||
| Depreciation | |||
| New equipment | 1,490,000 | ||
| Other | 1,200,000 | ||
| Division operating profit | $ | 3,810,000 | |
A sales representative from LSI Machine Company approached Oscar in October. LSI has for $7.6 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
Required:
a. What is Forbes Division's ROI if Oscar does not acquire the new machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).)
b. What is Forbes Division's ROI this year if Oscar acquires the new machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).)
c. If Oscar acquires the new machine and it operates according to specifications, what ROI is expected for next year? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).)
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