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.

Required:

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.