Question

Upper Division of Lower Company acquired an asset with a cost of $580,000 and a four-year life. The cash flows from the asset, considering the effects of inflation, were scheduled as follows:

Year	Cash Flow
1	$	185,000
2		265,000
3		285,000
4		305,000

The cost of the asset is expected to increase at a rate of 20 percent per year, compounded each year. Performance measures are based on beginning-of-year gross book values for the investment base. Ignore taxes. 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 % Year 2 % Year 3 % Year 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 % Year 2 % Year 3 % Year 4 %

Answer 1

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a.
Cost of the asset		$       580,000
Life		4 Year
Annual Depreciation		$       145,000
Year	Cash Flow	Depreciation	Net Income	ROI
	A	B	A-B=C	C/580000
1	$       185,000	$       145,000	$       40,000	6.90%
2	$       265,000	$       145,000	$     120,000	20.69%
3	$       285,000	$       145,000	$     140,000	24.14%
4	$       305,000	$       145,000	$     160,000	27.59%
b.
Year	Asset Cost	Depreciation	Cash Flow	Net Income	ROI
	A	B=A/4 Years	C	D=C-B	D/A
1	$       580,000	$       145,000	$     185,000	$          40,000	6.90%
2	$       696,000	$       174,000	$     265,000	$          91,000	13.07%
3	$       835,200	$       208,800	$     285,000	$          76,200	9.12%
4	$   1,002,240	$       250,560	$     305,000	$          54,440	5.43%