R& D Inc. has the following financial data for the current year (millions):
Earnings before R& D expenditures.......... $ 21.5
Interest expense................ $ 0.0
R& D expenditures................ $ 6.0
Total invested capital (excluding R& D assets) .... $ 100.0
Weighted average cost of capital........... 14%
Assume the tax rate is zero.

a. R& D Inc. writes off R& D expenditures as an operating expense. Calculate R& D Inc.’s EVA for the current year.
b. R& D Inc. decides to capitalize R& D and amortize it over three years. R& D expenditures for the last three years have been $ 6.0 million per year. Calculate R& D Inc.’ s EVA for the current year after capitalizing the current year and previous years’ R& D and amortizing the capitalized R& D balance.
c. In the specific case of R& D Inc., how does capitalizing and amortizing R& D expenditures instead of expensing R& D affect the incentive for managers approaching retirement to underspend on R& D at R& D Inc.

  • CreatedDecember 15, 2014
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