Question

Upper Division of Lower Company acquired an asset with a cost of $550,000 and a four-year life. The cash flows from the asset, considering the effects of inflation, were scheduled as follows:

The cost of the asset is expected to increase at a rate of 10 percent per year, compounded each year. Performance measures are based on beginning-of-year gross book values for the investment base. Ignore taxes.

Year Cash Flow

1 $200,000

2 $245,000

3 $280,000

4 $305,000

Required:

a. What is the ROI for each year of the asset's life, using a historical cost approach? (Enter your answers as a percentage rounded to 1 decimal place (i.e., 32.1).)

  

ROI

Year

1    _____ %

2   _____ %

3   _____ %

4   _____ %

b. What is the ROI for each year of the asset's life if both the investment base and depreciation are determined by the current cost of the asset at the start of each year? (Enter your answers as a percentage rounded to 1 decimal place (i.e., 32.1).)

ROI

Year   

1    _____ %

2   _____ %

3   _____ %

4   _____ %

Answer 1

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a.
Cost of the asset		$       550,000
Life		4 Year
Annual Depreciation		$       137,500
Year	Cash Flow	Depreciation	Net Income	ROI
	A	B	A-B=C	C/550000
1	$       200,000	$       137,500	$    62,500	11.36%
2	$       245,000	$       137,500	$ 107,500	19.55%
3	$       280,000	$       137,500	$ 142,500	25.91%
4	$       305,000	$       137,500	$ 167,500	30.45%
b.
Year	Asset Cost	Depreciation	Cash Flow	Net Income	ROI
	A	B=A/4 Years	C	D=C-B	D/A
1	$       550,000	$       137,500	$ 200,000	$          62,500	11.36%
2	$       605,000	$       151,250	$ 245,000	$          93,750	15.50%
3	$       665,500	$       166,375	$ 280,000	$       113,625	17.07%
4	$       732,050	$       183,013	$ 305,000	$       121,988	16.66%