Comfy Corporation manufactures furniture in several divisions, including the patio furniture division. The manager of the patio furniture division plans to retire in two years. The manager receives a bonus based on the division’s ROI, which is currently 7%. One of the machines that the patio furniture division uses to manufacture the furniture is rather old, and the manager must decide whether to replace it. The new machine would cost $35,000 and would last 10 years. It would have no salvage value. The old machine is fully depreciated and has no trade-in value. Comfy uses straight-line depreciation for all assets. The new machine, being new and more efficient, would save the company $5,000 per year in cash operating costs. The only difference between cash flow and net income is depreciation. The internal rate of return of the project is approximately 7%. Comfy Corporation’s weighted-average cost of capital is 5%. Comfy is not subject to any income taxes. Q. Assume that “investment” is defined as average net long-term assets (that is, after depreciation) during the year. Compute the project’s ROI for each of its first five years. If the patio furniture manager is interested in maximizing his bonus, would he replace the machine before he retires? Why or why not?
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Comfy Corporation manufactures furniture in several divisions, including the patio furniture division. The manager of the patio furniture division plans to retire in two years. The manager receives a bonus based on the division’s ROI, which is currently 7%. One of the machines that the patio furniture division uses to manufacture the furniture is rather old, and the manager must decide whether to replace it. The new machine would cost $35,000 and would last 10 years. It would have no salvage value. The old machine is fully
Q. Assume that “investment” is defined as average net long-term assets (that is, after depreciation) during the year. Compute the project’s ROI for each of its first five years. If the patio furniture manager is interested in maximizing his bonus, would he replace the machine before he retires? Why or why not?
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