You Are the Manager of an Operating Division of a Manufacturing

Essay

You are the manager of an operating division of a manufacturing company. Your division has $4,500,000 in assets, and your budgeted income statement for the current year follows:
$$\begin{array} { l c } \text { Reverues } & \$ 8,000,000 \\\text { Cash costs: } & \\ \text { Variable } & 1,000,000 \\\text { Fixed } & 3,750,000 \\\text { Depreciation } &1,375,000 \end{array}$$
Your company uses a performance evaluation and bonus plan, which is based on return on investment (ROI) computed with end-of-year gross asset balances.
In October, you discover that you can purchase a new machine for $3,250,000, which will enable you to expand the output of your division and save costs. The machine would have a salvage value of $250,000 and would be depreciated over 3 years using the straight-line method. It will increase output by 10% while reducing cash fixed costs by 5%. If you accept the machine, it will be installed in late December, but no depreciation will be taken on the new machine this year.
If you do buy this machine, you will have to dispose of the machine you are now using, which you just purchased last January. That machine cost you $2,500,000 but has no salvage value. $750,000 of the depreciation on the income statement is depreciation for this machine. In the ROI calculations, the company includes any gains or losses for equipment disposal in income for the year. You may safely ignore all taxes for this analysis.
Required:
a. What is your division's ROI this year if you do not acquire the new machine?
b. What is your division's ROI this year if you do acquire the new machine?
c. What is your division's expected ROI next year if the machine is acquired and meets expectations?