Item$4$

$7\mathrm{.}5$points

eBook

Print

References

Check my workCheck My Work button is now enabled$3$

Item $4$

Leidich Corporation manufactures hospital equipment. The Measurement Division $($MD$)$ manufactures testing and measurement equipment including a special cardiovascular instrument. MD started the year with $$18\mathrm{.}25$ million in other assets. At the beginning of the current year, MD invested $$19\mathrm{.}5$ million in automated equipment for instrument assembly. The division$$s expected income statement at the beginning of the year was as follows:

Sales revenue$ $42,000,000$Operating costs$$Variable$6,570,000$Fixed $($all cash$)12,200,000$Depreciation$$New automated equipment$3,100,000$Other$2,250,000$Division operating profit$ $17,880,000$

A sales representative from South Street Manufacturing $($SSM$)$ approached the manager of MD in late November. SSM is willing to sell for $$9\mathrm{.}4$ million a new assembly machine that offers significant improvements over the automated equipment MD acquired at the beginning of the year. The new equipment would expand division output by $12$ percent while reducing cash fixed costs by $$852,400.$ It would be depreciated for accounting purposes over a four$-$year life. Depreciation would be net of the $$1,200,000$ salvage value of the new machine. The new equipment meets Leidich's cost of capital criterion. If MD purchases the new machine, it must be installed prior to the end of the year. For practical purposes, though, MD can ignore depreciation on the new machine because it will not go into operation until the start of the next year.

MD will have to dispose of the old machine because the new machine would be installed in the same area. The old machine has no salvage value.

Leidich has a performance evaluation and bonus plan based on ROI. The return includes any losses on disposal of equipment. Investment is computed based on the end$-$of$-$year balance of assets, net book value. Ignore taxes.

Assume that the performance measurement and bonus plans at Leidich Corporation are based on residual income instead of ROI. The company uses a cost of capital of $10$ percent in computing residual income.

Required:

What is Measurement Division's residual income if it does not acquire the new machine?

What is Measurement Division's residual income this year if it does acquires the new machine?

If the division acquires the new machine and operates it according to specifications, what residual income is expected for next year?

Note: For all the requirements, enter your answers in thousands of dollars. Negative amounts should be indicated by a minus sign.