Early in January 2010, Tellco, Inc. acquired a new machine and incurred $100,000 of interest, installation , and overhead costs that should have been capitalized but were expensed. The company earned net operating income of $1,000,000 on average total assets of $8,000,000 for 2010. Assume that the total cost of the new machine will be depreciated over 10 years using the straight-line method.
A. Calculate the ROI for Tellco, Inc for 2010
B. Calculate the ROI for Tellco, Inc for 2010 assuming that the $100,000 had been capitalized and depreciated over 10 years using the straight-line method.
C. Given your answers to a and b, why would the company want to account for the expenditure as an expense?
D. Assuming that the $100,000 is capitalized, what will be the effect on ROI for 2011 and subsequent years, compared to expensing the interest, installation, and overhead costs in 2010? Explain your answer.
a) ROI = operating income/average total assets
b) Amount will be depreciated 100,000
Estimate useful life over 10 years
Depreciation expense in current year 10,000
Operating Income reported 1,000,000
Installation and overhead costs (100,000)
Decrease in depreciation expense 10,000
ROI = operating income/average total assets
The ROI for Tellco was calculated. The ROI is compared over subsequent years.