Doorharmony Company makes doorbells. It has a weighted average cost of capital of 8% and total assets of $ 5,450,000. Doorharmony has current liabilities of $ 600,000. Its operating income for the year was $ 640,000. Doorharmony does not have to pay any income taxes. One of the expenses for accounting purposes was a $ 150,000 advertising campaign. The entire amount was deducted this year, although the Doorharmony CEO believes the beneficial effects of this advertising will last 4 years.
1. Calculate residual income (using the weighted- average cost of capital), assuming Doorharmony defines investment as total assets.
2. Calculate EVA for the year. Adjust both the assets and operating income for advertising assuming that for the purposes of economic value added the advertising is capitalized and amortized on a straight- line basis over 4 years.
3. Discuss the difference between the outcomes of requirements 1 and 2. Which measure would you recommend?