Atomic Electronics is considering instituting a plan whereby managers will be evaluated and rewarded based on a measure of economic value added (EVA). Before adopting the plan, management wants you to calculate what EVA will be in 2018, based on financial forecasts for 2018 and prior financial data.
.....................................................................Fiscal Forecast 2018
Total assets ................................................................$ 60,500,000
Noninterest-bearing current liabilities ...................................23,100,000
Sales ........................................................................110,000,000
Net income ....................................................................6,050,000
Interest expense ..............................................................1,320,000
Research and development .................................................2,640,000
Tax rate ..............................................................................35%
Cost of capital .......................................................................15%
Research and development expenditures in 2016 and 2017 were $1,200,000 and $2,100,000, respectively. In calculating EVA, prior research and development will be capitalized and amortized assuming a 3-year life (i.e., one-third will be expensed in the year incurred, and two-thirds will be capitalized and expensed in the following 2 years).
Required
a. Explain why it is important to capitalize research and development if managers are to be rewarded based on EVA.
b. Calculate forecasted EVA for 2018.
c. Will management be likely to support use of EVA as a financial performance measure?