Reference no: EM132719235

Your division manufactures the spare part needed to produce the main product. On January 1 of this year, you as the manager of the division invested $2 million in a new equipment.

At that time, your expected income statement for this year was as follows:

Sales revenues $ 3,200,000
Operating costs:
Variable (cash expenditures) $ 400,000
Fixed (cash expenditures) 1,500,000
Equipment depreciation 300,000
Other depreciation 250,000
Total operating costs $2,450,000
Operating profits (before taxes) $ 750,000

• On October 25 of this year, a sales representative for Machine Specialized Company approached you and offered to rent to your division a new sophisticated machine that would be installed on December 31 of this year for an annual rental charge of $460,000. The new equipment would enable you to increase your division's annual revenue by 10%. The more efficient machine would decrease fixed cash expenditures by 5%. You will have to write off the cost of the new equipment this year because it has no salvage value. Equipment depreciation shown in the income statement is for the new equipment.

• Your bonus is determined as a percentage of your division's operating profits before taxes. Equipment losses are included in the bonus and operating profit computation.

• Ignore taxes and any effects on operations on the day of installation of the new machine. 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:

Problem a. What is the difference in this year's divisional operating profit if the new machine is rented and installed on December 31 of this year?

Problem b. What would be the effect on next year's divisional operating profit if the new machine is rented and installed on December 31 of this year?

Problem c. Would you rent the new machine? Why or Why not?