Upper Division of Lower Company acquired an asset with a cost of $620,000 and a four-year life. The cash flows from the asset, considering the effects of inflation, were scheduled as follows. Year 1 2 3 4 Cash Flow $229,000 259,000 289,000 304,000 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. Assume that the company uses a 15 percent cos of capital. Required: a. What is the residual income for each year of the asset's life, using a historical cost approach? b. What is the residual income 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? (Negative amounts should be indicated by a minus sign.) Year 1 Year 2 Year 3 Year 4 Residual Income Historical Cost Current Cost
Upper Division of Lower Company acquired an asset with a cost of $620,000 and a four-year life. The cash flows from the asset, considering the effects of inflation, were scheduled as follows. Year 1 2 3 4 Cash Flow $229,000 259,000 289,000 304,000 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. Assume that the company uses a 15 percent cos of capital. Required: a. What is the residual income for each year of the asset's life, using a historical cost approach? b. What is the residual income 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? (Negative amounts should be indicated by a minus sign.) Year 1 Year 2 Year 3 Year 4 Residual Income Historical Cost Current Cost
Chapter10: Capital Budgeting: Decision Criteria And Real Option
Section: Chapter Questions
Problem 20P
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Transcribed Image Text:Upper Division of Lower Company acquired an asset with a cost of $620,000 and a four-year life. The cash flows from the asset,
considering the effects of inflation, were scheduled as follows.
Year Cash Flow
1
2
3
4
$229,000
259,000
289,000
304,000
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. Assume that the company uses a 15 percent cost
of capital.
Year 1
Year 2
Year 3
Year 4
Required:
a. What is the residual income for each year of the asset's life, using a historical cost approach?
b. What is the residual income 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?
(Negative amounts should be indicated by a minus sign.)
Residual Income
Historical Cost Current Cost
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