Analyze the Impact of a Decision on Income Statements: You have been appointed manager of an operating
Question:
Analyze the Impact of a Decision on Income Statements:
You have been appointed manager of an operating division of HI-TECH, Inc., a manufacturer of products using the latest developments in microprocessor tech- nology. Your division manufactures the chip assembly. ZP-1. On January 1 of this year, you invested $1 million in automated processing equipment for chip assembly. At that time, your expected income statement was as follows:
On October 25 of this year, you are approached by a sales representative for the Mammoth Machine Company. Mammoth wants to rent to your division a new assembly machine which would be installed on December 31. The new equipment has an annual rental charge of $460,000. The new equipment would enable you to increase your division annual revenue by 10 percent. Fixed cash expenditures would decrease by 5 percent per year due to the more efficient machine. You will have to write off the cost of the old machine this year because it has no salvage value. Equipment depreciation in the income statement above is for the old machine.
Your bonus is determined as a percentage of your division's operating profits before taxes. Equipment losses are included in the bonus and operating profit computation.
Ignore taxes and any effects on operations on the day of installation of the new machine. Assume the data given in your expected income statement is the same for this year and next year if the current equipment is kept.
Required:
a. What is the difference in this year's divisional operating profit if the new machine is rented and installed on December 31 of this year?
b. What would be the effect on next year's divisional operating profit if the new machine is rented and installed on December 31 of this year?
c. Would you rent the new equipment? Why or why not?
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