A division is considering the acquisition of a new asset that will cost $740,000
ID: 2473547 • Letter: A
Question
A division is considering the acquisition of a new asset that will cost $740,000 and have a cash flow of $281,000 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.
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 25 percent? (Round "ROI" to 1 decimal place. Negative amount should be indicated by a minus sign. Round your dollar values to nearest whole dollar.)
Year 1, 2, 3, 4 ---- 1.Find the Investment Base 2. ROI 3. Residual Income
Required: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 25 percent? (Round "ROI" to 1 decimal place. Negative amount should be indicated by a minus sign. Round your dollar values to nearest whole dollar.)
Year 1, 2, 3, 4 ---- 1.Find the Investment Base 2. ROI 3. Residual Income
Explanation / Answer
All Amounts in $ Calculation of ROI yearwise Depreciation on Asset per year 185000 $ Cash Flow per year 281000 $ Net Income per year 96000 $ Investment Made (Cost of Asset) 740000 $ ROI (Return on Investment) calculated year wise Year Asset Value 0 740000 1 555000 2 370000 3 185000 4 0 ROI = Net Income / Average Asset Cost Average Asset Cost for Year 1 = (550000+740000)/2 = 647500 Investment Base - Year 1 Average Asset Cost for Year 2 = (555000 + 37000)/2 = 462500 Investment Base - Year 2 Average Asset Cost for Year 3 = (370000 + 185000)/2 = 277500 Investment Base - Year 3 Average Asset Cost for Year 4 = (185000 + 0)/2 = 92500 Investment Base - Year 4 ROI Yearwise Year ROI 1 14.83% 2 20.76% 3 34.59% 4 103.78% With the Cost of Capital being 25% per year Year Year Year Year 1 2 3 4 Net Income 96000 96000 96000 96000 Estimated Return on Income @ 25% of Capital Base 161875 115625 69375 23125 Residual Income/(Loss) -65875 -19625 26625 72875
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