ions, which are based on the products they produce. Canal Division is smaller, and the lives of the products it produces tend to be shorter than those produced by the larger Lake Division. Selected financial data for the past year are shown in the following table. Divisional investment is as of the beginning of the year. Navarre uses an 8 percent cost of capital and beginning-of-the-year investment when computing ROI and residual income. Ignore income taxes. Division Canal ($000) Lake ($000) Allocated corporate overhead $ 4,100 $ 9,600 Cost of goods sold 20,000 30,000 Divisional investment 60,100 400,000 R&D 12,000 32,000 Sales 50,000 100,000 Selling, general and administrative (excluding R&D) 4,500 8,000
Navarre Energy Research specializes in developing and commercializing new products. It is organized into two divisions, which are based on the products they produce. Canal Division is smaller, and the lives of the products it produces tend to be shorter than those produced by the larger Lake Division. Selected financial data for the past year are shown in the following table. Divisional investment is as of the beginning of the year. Navarre uses an 8 percent cost of capital and beginning-of-the-year investment when computing
| Division | ||
|---|---|---|
| Canal ($000) | Lake ($000) | |
| Allocated corporate |
$ 4,100 | $ 9,600 |
| Cost of goods sold | 20,000 | 30,000 |
| Divisional investment | 60,100 | 400,000 |
| R&D | 12,000 | 32,000 |
| Sales | 50,000 | 100,000 |
| Selling, general and administrative (excluding R&D) | 4,500 | 8,000 |
R&D is assumed to have a three-year life in Canal Division and an eight-year life in Lake 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.
The manager of the Canal Division complains that the calculation of EVA is unfair because a much longer life is assumed for the Lake Division in calculating EVA. The manager of Lake Division responds that EVA is supposed to reflect economic reality and that the reality is that R&D investments in Lake Division do have a longer life.
Required:
a. Assume that the economic life of R&D investments is three years in the Canal Division. What economic life would the R&D investments in the Lake Division have to make EVA in the two divisions equal?
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