Investment: $300,000 Annual sales revenues $180,000 Annual cash costs = $80,000
ID: 2586091 • Letter: I
Question
Investment: $300,000 Annual sales revenues $180,000 Annual cash costs = $80,000 4-year useful life, no salvage value Jonas Partners faces a 30% tax rate on income and is aware that the tax authorities will only permit straight- line depreciation for tax purposes. The firm has an after-tax required rate of return of 8%. 1. Based on net present value considerations, is this a project Jonas Partners would want to take? 2. Jonas Partners use straight-line depreciation for internal accounting and measure investment as the Required net book value of assets at the start of the year. Calculate the residual income in each year if the project were adopted. Demonstrate that the conservation property of residual income, as described on page 900, holds in this example 3. 4. If Ryan Alcoa is evaluated on the residual income of the projects he undertakes, would he take this project? Explain.Explanation / Answer
Answer to part 1
W.Note:
Calculation of Depreciation
Decision- Jonas Partner can take up the project as the NPV of the project at the required rate of return is positive.
Answer to part 2
W.Note
Average Operating Assets
Answer to part 3
Residual income approach in several respect the only performance measure that acheive goal congruence due to its conservative approach. Residual income allows the manager to accept all the projects having positve NPV and it does not involve a ratio of accounting numbers.
Answer to part 4
ROI = Operating Income / operating assets
The residual income is positive in each case and it increases the wealth of the Jonas. However in deciding whether to accept the project or not the residual income itself is not sufficient , so we calculate ROI. As the ROI is increasing each year the project can be accepted.
Period Cash Flow PVF at 8% Present Value Year 0 -300000 1.0000 (300,000) Year 1-4 92500 3.3121 306,369 Net Present Value (NPV) 6,369Related Questions
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