Return on Investment and Incentive/Goal-Congruence Issues; Residual Income;Spreadsheet Application Assume the purchase of new delivery trucks used in a product-deliveryservice. This equipment is needed to improve delivery service and respond to recent environmentalgoals embraced by the company. The cost of the new equipment is $1,200,000; the expected usefullife of these assets is 5 years. Estimated salvage value at the end of 5 years is $0. The company willdepreciate these assets over a 5-year period using straight-line depreciation. The anticipated increasein operating income (before depreciation deductions) attributable to the use of the new equipmentis $360,000. Ignore taxes. Assume in all cases below that the proposed investment, on a discountedcash flow basis, is desirable (i.e., that its estimated net present value [NPV] is positive).Required1. Generate, using an Excel spreadsheet, a schedule of the year-by-year ROIs associated with this investment opportunity. For purposes of these calculations, define the investment base (denominator of theROI ratio) as average net book value (NBV) of the assets during the year. What is the ROI in year 3using net book value?2. Generate a second schedule showing the year-by-year ROIs for this investment opportunity under theassumption that the denominator in the ROI calculation is defined as the gross book value of the assetsto be acquired. What is the ROI in year 3 using gross book value?3. Why do the results differ in requirements 1 and 2? What behavioral issue is associated with the use ofthe method used in requirement 1 compared to the method used in requirement 2?4. What impact would the use of an accelerated depreciation method have on the conclusions in requirements 1 and 2? For example, prepare a new schedule of annual ROIs under the assumption that thedouble-declining-balance depreciation method is used. (Assume a switch to straight-line depreciation inyear 4. Thus, the total depreciation charge over the 5-year period should be $1.2 million.)5. Would the use of the residual income (RI) measure of financial performance eliminate the behavioral issueraised in requirement 4? Why or why not? For the methods specified in requirements 1, 2, and 4, show theyear-by-year RIs for this investment, based on a weighted-average cost of capital (WACC) of 8%. For eachof the four options (annual ROIs with NBV as the denominator; annual ROIs with GBV as the denominator; and annual ROIs for both scenarios repeated, assuming accelerated depreciation), base the imputedinterest charge each year on a simple average of beginning-of-year and end-of-year asset values.
Spreadsheet Application Assume the purchase of new delivery trucks used in a product-delivery
service. This equipment is needed to improve delivery service and respond to recent environmental
goals embraced by the company. The cost of the new equipment is $1,200,000; the expected useful
life of these assets is 5 years. Estimated salvage value at the end of 5 years is $0. The company will
in operating income (before depreciation deductions) attributable to the use of the new equipment
is $360,000. Ignore taxes. Assume in all cases below that the proposed investment, on a discounted
cash flow basis, is desirable (i.e., that its estimated
Required
1. Generate, using an Excel spreadsheet, a schedule of the year-by-year ROIs associated with this investment opportunity. For purposes of these calculations, define the investment base (denominator of the
ROI ratio) as average net book value (NBV) of the assets during the year. What is the ROI in year 3
using net book value?
2. Generate a second schedule showing the year-by-year ROIs for this investment opportunity under the
assumption that the denominator in the ROI calculation is defined as the gross book value of the assets
to be acquired. What is the ROI in year 3 using gross book value?
3. Why do the results differ in requirements 1 and 2? What behavioral issue is associated with the use of
the method used in requirement 1 compared to the method used in requirement 2?
4. What impact would the use of an accelerated depreciation method have on the conclusions in requirements 1 and 2? For example, prepare a new schedule of annual ROIs under the assumption that the
double-declining-balance depreciation method is used. (Assume a switch to straight-line depreciation in
year 4. Thus, the total depreciation charge over the 5-year period should be $1.2 million.)
5. Would the use of the residual income (RI) measure of financial performance eliminate the behavioral issue
raised in requirement 4? Why or why not? For the methods specified in requirements 1, 2, and 4, show the
year-by-year RIs for this investment, based on a weighted-average cost of capital (WACC) of 8%. For each
of the four options (annual ROIs with NBV as the denominator; annual ROIs with GBV as the denominator; and annual ROIs for both scenarios repeated, assuming accelerated depreciation), base the imputed
interest charge each year on a simple average of beginning-of-year and end-of-year asset values.
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