Johnson Controls designed a new controller that produces high frequency output.

Question

Johnson Controls designed a new controller that produces high frequency output.  The new controllers took 3 years to develop at a cost of $10 million after taxes over that period.  What is left is an investment of $22 million after taxes in new production equipment.  This new controller is projected to brin in free cash  flows of $5 million each year for 10 years. The facility that the origional controller was made in could be sold for $3 million to a competitor after taxes.

a.  How should the $10 million in R&D be treated?

b.  How should the $3 million from the sale of the existing producion facility be treated?

c.  Using the above information what are the cash flows of the associated new controllers?

Explanation / Answer

a. $10 million in R&D should be treated as deferred revenue expenditure and should be writen off over the useful life of the controller i.e 10 yrs . So therefore , $1million should be writen off each year for a period of 10yrs .$1 million every yera will be charged in income statement .

b.$3 million should be treated as income for the relevant year . In other words, $3million will be added to the income statement assuming its written down is NIL at the time of sale.

c.

Cash flows of new controller cash outflow cost of controller 10000000 Cash inflows sale of old controller 3000000 cash inflows from controller $5m*10 50000000 Note discounting rate is not given in que,hence ignored

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