Integrative Cases 2-85 (Algo) Analyze the Impact of a Decision on Income Statements (LO 2-2)

You were appointed the manager of Storage Solutions Section (S3) at Milbank Technologies, a manufacturer of mobile computing parts and accessories late last year. S3 manufactures a drive assembly for the companys most popular product. Your bonus is determined as a percentage of your divisions operating profits before taxes.

One of your first major investment decisions was to invest $2.13 million in automated testing equipment for device testing. The equipment was installed and in operation on January 1 of this year.

This morning, the assistant manager of the division told you about an offer by Joliet Systems. Joliet wants to rent to S3 a new testing machine that could be installed on December 31 (only two weeks from now) for an annual rental charge of $473,000. The new equipment would enable you to increase your divisions annual revenue by 7 percent. This new, more efficient machine would also decrease fixed cash expenditures by 6 percent.

Without the new machine, operating revenues and costs for the year are estimated to be as follows. Sales revenue and fixed and variable operating costs are all cash.

Sales revenue$ 3,330,000Variable operating costs413,000Fixed operating costs1,630,000Equipment depreciation313,000Other depreciation263,000

If you rent the new testing equipment, S3 will have to write off the cost of the automated testing equipment this year because it has no salvage value. Equipment depreciation shown in the income statement is for this automated testing equipment. Equipment losses are included in the bonus and operating profit computation.

Because the new machine will be installed on a company holiday, there will be no effect on operations from the changeover. Ignore any possible tax effects. Assume that the data given in your expected income statement are the actual amounts for this year and next year if the current equipment is kept.

Required:

a. Assume the new testing equipment is rented and installed on December 31. What will be the impact on this year's divisional operating profit?

b. Assume the new testing equipment is rented and installed on December 31. What will be the impact on next year's divisional operating profit?

c. Would you rent the new equipment?