Chapter 23, Problem 23.28E

Capital budgeting, RI. Ryan Alcoa, a new associate at Jonas Partners, has compiled the following data for a potential investment for the firm:

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. 1. Based on net present value considerations, is this a project Jonas Partners would want to take?

Required

1. 2. Jonas Partners use straight-line depreciation for internal accounting and measure investment as the net book value of assets at the start of the year. Calculate the residual income in each year if the project were adopted.
2. 3. 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.