Equipment Replacement and Performance Measures: You have been appointed manager of an operating division of HI-TECH, Inc., a manufacturer of products using the latest microprocessor technology. Your division has $800,000 in assets and manufactures a special chip assembly. On January 2 of the current year, you invested $1 million in automated equipment for chip assembly. At that time, your expected income statement was:

On October 25 you were approached by a sales representative from Mammoth Machine Company. Mammoth offers a new assembly machine at a cost of $1.3 million that offers significant improvements over the equipment you bought on January 2. The new equipment would expand department output by 10 percent while reducing cash fixed costs by 5 percent. The new equipment would be depreciated for accounting purposes over a three-year life. Depreciation would be net of the $100,000 salvage value of the new machine. The new equipment meets your company's 20 percent cost of capital criterion. If you purchase the new machine. it must be installed prior to the end of the year. For practical purposes, though, you can ignore depreciation on the new machine because it will not go into operation until the start of the next year. The old machine must be disposed of to make room for the new machine. The old machine has no salvage value. Your company has a performance evaluation and bonus plan based on ROI. The return includes any losses on disposals of equipment. Investment is computed based on the end-of-year balance of assets, net book value.

Required:

a. What is your division's ROI if the new machine is not acquired?

b. C. What is your division's ROI this year if the new machine is acquired? If the new machine is required and operates according to specifications, what ROI would be expected for next year?

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Sales revenue Operating costs: Variable Fixed (all cash) Depreciation: New equipment Other Division operating profit $3,200,000 400,000 1,500,000 300,000 250,000 $ 750,000