A bank considers acquiring new computer equipment. The computer will cost $160,0

Question

A bank considers acquiring new computer equipment. The computer will cost $160,000 and result in a cash savings of $70,000 per year (excluding depreciation) for each of the five years of the asset’s life. It will have no salvage value after five years. Assume straight-line depreciation (depreciation expensed evenly over the life of the asset). The company’s tax rate is 15 percent, and there are no current liabilities associated with this investment.

a. What is the ROI for each year of the asset's life if the division uses begininging of year net book value asset balances for the computation?

b. what is the economic value added each year if the weighted average cost of capital is 25 percent?

Explanation / Answer

a.

Return on investment is calculated using the below mentioned formula:

Return on Investment = Income/Invested Capital

ROI for each year of asset's life is calculated as under:

b.

EVA is calculated as under:

Net book value of asset is taken for EVA computation.

Year Investment (a) Depreciation (b) Closing Value of investment c= (a-b) Income (d) Operating Income e= (d-b) ROI f=e/a 1 160,000 32000 128,000 70,000 38,000 23.8 2 128000 32000 96,000 70,000 38,000 29.7 3 96000 32000 64,000 70,000 38,000 39.6 4 64000 32000 32,000 70,000 38,000 59.4 5 32000 32000 0 70,000 38,000 118.8

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