Reference no: EM133173907

Question - Division A of Kennesaw, Inc. has $800,000 in assets and manufactures part #589. On January 1 of the current year Division A's manager invested $1,000,000 in automated equipment for part #589 assembly. At that time, Division A's expected income statement was as follows:

Sales revenue $3,200,000

Operating costs:

Unit level (variable) 400,000

Facility level (fixed, all cash) 1,500,000

Depreciation

New equipment 300,000

Other 250,000

Division operating profit $750,000

On November 16, a sales representative from Rome, Inc. approached Division A's manager. For $1,300,000, Rome offers a new assembly machine with significant improvement over the equipment bought on January 1. The new equipment would expand division output by 10 percent while reducing cash fixed cost by 5 percent. The new equipment would be depreciated for accounting purposes over a three-year period. Depreciation would be net of the new machine salvage value of $100,000. The new equipment meets company's 20 percent cost of capital criterion. If the new machine is purchased, it must be installed prior to the end of the year. For practical purposes, though, depreciation on the new machine can be ignored because it will not go into operation until the start of the next year.

The old machine, which has no salvage value, must be disposed to make room for the new machine.

The company has a performance evaluation and bonus plan based on ROI. The returns includes any loses of disposals of equipment. Investment is computed based on the average balance of assets for the year, net book value.

Required -

a. What is division's ROI this year if it does not acquire the new machine?

b. What is division's ROI this year if it does acquire the new machine?

c. If the new machine is acquired and operates according to specifications, what ROI is expected to be next year?

d. Is it ethical to decline to purchase the new machine? Explain.