Effect of Proposals on Divisional Performance
A condensed income statement for the Electronics Division of Gihbli Industries Inc. for the year ended December 31 is as follows:
Sales |
$1,870,000 |
Cost of goods sold |
1,472,700 |
Gross profit |
$ 397,300 |
Operating expenses |
229,000 |
Income from operations |
$ 168,300 |
Invested assets |
$1,700,000 |
Assume that the Electronics Division received no cost allocations from service departments.
The president of Gihbli Industries Inc. has indicated that the division’s return on a $1,700,000 investment must be increased to at least 11.7% by the end of the next year if operations are to continue. The division manager is considering the following three proposals:
Proposal 1: Transfer equipment with a book value of $340,000 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would be less than the amount of depreciation expense on the old equipment by $61,200. This decrease in expense would be included as part of the cost of goods sold. Sales would remain unchanged.
Proposal 2: Reduce invested assets by discontinuing a product line. This action would eliminate sales of $361,300, reduce cost of goods sold by $241,400, and reduce operating expenses by $106,300. Assets of $860,700 would be transferred to other divisions at no gain or loss.
Proposal 3: Purchase new and more efficient machinery and thereby reduce the cost of goods sold by $224,400 after considering the effects of depreciation expense on the new equipment. Sales would remain unchanged, and the old machinery, which has no remaining book value, would be scrapped at no gain or loss. The new machinery would increase invested assets by $850,000 for the year.
Required: