Reference no: EM131789299

The D Division of the DEF Corporation has budgeted after-tax profits of $1 million for 2013. It has budgeted assets as of January 1, 2013, of $10 million, consisting of $4 million in current assets and $6 million in property, plant and equipment (PP&E). PP&E assets are included in the asset base at gross book value. The net book value of these assets is $3 million and they are depreciated over a 10-year period on a straight-line basis.

Senior management of DEF Corporation has approached the manager of the D Division with a proposal to upgrade some of the division's property, plant & equipment. The financial details of the proposal are as follows:

New Equipment
Estimated cost		$2,000,000
Estimated after-tax annual savings		$300,000
Estimated life		10 years
Old equipment to be replaced
Original cost		$1,500,000
Original estimate of life		10 years
Present age		7 years
Present book		$450,000
Salvage value		$0

If the project is accepted, the new equipment will be purchased on January 1^st, 2013.

Analysis done by the senior management of DEF Corporation has determined that the acquisition of the new equipment would improve the company's overall ROI.  The manager of Division D is compensated with a base salary and is also eligible for a bonus if the Division's ROI is higher than what was budgeted. (Budgeted ROI can be determined by analyzing the status quo situation.)

Required:

• Calculate the anticipated ROI for 2013 and 2014, under the following conditions:
  • Assume the investment in property, plant & equipment assets is accounted for on a gross book value basis for purposes of the ROA calculation.
  • Assume the investment in property, plant & equipment is accounted for on a net book value basis for purposes of the ROA calculation.
  • Based on your calculations in part (a), is the manager likely to acquire the new equipment?
• Calculate the actual ROI for 2013 and 2014 assuming the investment is overrun by $500,000 and the annual savings are only $200,000 and assuming the following conditions:
• Assume the investment in property, plant & equipment is accounted for on a gross book value basis for purposes of the ROI calculation.
• Assume the investment in property, plant & equipment is accounted for on a net book value basis for purposes of the ROI calculation.
• Regardless of your analysis in part 1, assume that the manager of Division D decides not to undertake the proposal. What action, if any, should the senior management of DEF Corporation undertake? Explain.