Ami Smith is the director of the canoe division of Watersport Inc. The actual net income and the total assets of the division are $500,000 and $2,500,000, respectively. Smith is evaluated by Watersport on the return on investment of the division. The canoe division’s equipment was purchased six years ago and has an expected useful life of 10 years, with no salvage value at the end of its life. The market value of the equipment is $210,000, which is equal to its current tax basis book value, but Smith wants to replace the equipment with new high-technology equipment that just came out on the market. This high-tech equipment can be bought for $1,170,000, and Watersport will incur a cost of $30,000 for installation. The new equipment will have a 10-year useful life, with no salvage value. The division’s cost savings will be approximately $250,000 per year due to the new equipment. The company’s income tax rate is 35%, and its cost of capital is 14%. The CCA rate is 25%.

Required:

1. Should the company make the investment? Show your calculations, and briefly explain your recommendation.

2. Briefly explain how Smith’s return on investment performance in year 1 and year 2 will be affected by this investment. Show your calculations.