Question

A division is considering the acquisition of a new asset that will cost $2,950,000 and have a cash flow of $740,000 per year for each of the four years of its life. Depreciation is computed on a straight-line basis with no salvage value. Ignore taxes. Required: a. & b. What is the ROI for each year of the asset's life if the division uses beginning-of-year asset balances and net book value for the computation? What is the residual income each year if the cost of capital is 8 percent?

Answer 1

Answer and Explanation:

The computation of ROI for each year of the asset's life and residual income each year is shown below:-

Year Investment base ROI Residual income

1 $2,950,000 8% -$233,500

2 $2,212,500 11% -$233,500

3 $1,475,000 17% -$115,500

4 $737,500 34% -$56,500

ROI = Net income ÷ Total investment × 100

Net Income = Cash flow - Depreciation

Residual income = Net income - (Investment × Cost of capital)

Depreciation = Investment base ÷ 4 years

The return on investment and the residual income can be find out by using the excel spreadsheet. Kindly find it in the attachment