Refer to the information in problem 18.21. The manager of Sandy Point Construction is considering a new project. She can buy or lease equipment that will allow the quicker construction and erection of frames on-site. The purchase price of the equipment is $150 000 or the cost to lease is $2000 per month. She estimates the return (incremental revenues minus incremental expenses, including lease cost) to be $40 000 per year. She knows that purchasing the equipment will increase the value of average operating assets. If she leases the equipment, expenses will increase, but not assets. In other words, the lease will be accounted for as an operating lease. Although it is more cost effective to purchase the equipment, she has decided to lease it.

Required

(a) Calculate the new ROI if the equipment is (i) purchased, or (ii) leased.

(b) Calculate the new residual income if the equipment is (i) purchased, or (ii) leased.

(c) One of the adjustments that can be made using EVA is to treat all operating lease costs as if they were purchases — in other words, to capitalise the lease. If Sandy Point Construction used EVA with this adjustment, how might the manager’s incentives and behaviour change? Explain.