Colonial Pharmaceuticals is a small firm specializing in new products. It is organized into two divisions, which are based on the products they produce. AC Division is smaller and the life of the products it produces tend to be shorter than those produced by the larger SO Division. Selected financial data for the past year is shown as follows. Divisional investment is as of the beginning of the year. Colonial Pharmaceuticals uses a 9 percent cost of capital and uses beginning-of-the-year investment when computing ROI and residual income. Ignore income taxes. so Division $ 1,500 AC Division Allocated corp. overhead Cost of goods sold Divisional investment 630 3,260 7,600 9,600 77,000 4,200 20,600 1,230 R&D 1,875 Sales 9,200 SG&A 790 R&D is assumed to have a two-year life in the AC Division and a nine-year life in the SO division. All R&D expenditures are spent at the beginning of the year. Assume there are no current liabilities and (unrealistically) that no R&D investments had taken place before this year. Al, the manager of the AC Division, complains that the calculation of EVA is unfair, because a much longer life is assumed for the SO Division in calculating EVA. Sean, the manager of SO, responds that EVA is supposed to reflect economic reality and that the reality is that R&D investments in SO Division do have a longer life. Required: a. Assume that the economic life of R&D investments is two years in the AC Division. What economic life would the R&D investments in the SO Division have to make EVA in the two divisions equal? (Round EVA to 2 decimal places and final answer to 1 decimal places. Do not round intermediate calculations.)
Colonial Pharmaceuticals is a small firm specializing in new products. It is organized into two divisions, which are based on the products they produce. AC Division is smaller and the life of the products it produces tend to be shorter than those produced by the larger SO Division. Selected financial data for the past year is shown as follows. Divisional investment is as of the beginning of the year. Colonial Pharmaceuticals uses a 9 percent cost of capital and uses beginning-of-the-year investment when computing ROI and residual income. Ignore income taxes. so Division $ 1,500 AC Division Allocated corp. overhead Cost of goods sold Divisional investment 630 3,260 7,600 9,600 77,000 4,200 20,600 1,230 R&D 1,875 Sales 9,200 SG&A 790 R&D is assumed to have a two-year life in the AC Division and a nine-year life in the SO division. All R&D expenditures are spent at the beginning of the year. Assume there are no current liabilities and (unrealistically) that no R&D investments had taken place before this year. Al, the manager of the AC Division, complains that the calculation of EVA is unfair, because a much longer life is assumed for the SO Division in calculating EVA. Sean, the manager of SO, responds that EVA is supposed to reflect economic reality and that the reality is that R&D investments in SO Division do have a longer life. Required: a. Assume that the economic life of R&D investments is two years in the AC Division. What economic life would the R&D investments in the SO Division have to make EVA in the two divisions equal? (Round EVA to 2 decimal places and final answer to 1 decimal places. Do not round intermediate calculations.)
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:Colonial Pharmaceuticals is a small firm specializing in new products. It is organized into two divisions, which are based on the
products they produce. AC Division is smaller and the life of the products it produces tend to be shorter than those produced by the
larger SO Division. Selected financial data for the past year is shown as follows. Divisional investment is as of the beginning of the
year. Colonial Pharmaceuticals uses a 9 percent cost of capital and uses beginning-of-the-year investment when computing ROI and
residual income. Ignore income taxes.
so Division
$ 1,500
AC Division
$ 630
Allocated corp. overhead
Cost of goods sold
3,260
7,600
77,000
Divisional investment
9,600
R&D
4,200
1,875
9,200
Sales
20,600
SG&A
790
1,230
R&D is assumed to have a two-year life in the AC Division and a nine-year life in the SO division. All R&D expenditures are spent at the
beginning of the year. Assume there are no current liabilities and (unrealistically) that no R&D investments had taken place before this
year.
Al, the manager of the AC Division, complains that the calculation of EVA is unfair, because a much longer life is assumed for the SO
Division in calculating EVA. Sean, the manager of SO, responds that EVA is supposed to reflect economic reality and that the reality is
that R&D investments in SO Division do have a longer life.
Required:
a. Assume that the economic life of R&D investments is two years in the AC Division. What economic life would the R&D investments in
the SO Division have to make EVA in the two divisions equal? (Round EVA to 2 decimal places and final answer to 1 decimal places.
Do not round intermediate calculations.)
Economic life
years
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