A startup software firm, Hidden Code Co., budgets R&D expenditures of $120 (million) for the foreseeable future.
Question:
A startup software firm, Hidden Code Co., budgets R&D expenditures of $120 (million) for the foreseeable future.
Each dollar of R&D expenditure is expected to generate $2 dollars of revenue for 3 full years following the expenditure, then zero revenues thereafter.
Additional information: The company’s current level of net operating assets is $90 million. There is no outstanding debt. Operating expenses (other than software R&D costs) are expected to be 75 percent of sales.
1. Calculate Hidden Widgets’ expected operating income and RNOA for the next 3 years under the assumption that software R&D costs are expensed immediately.
2. Calculate RNOA for the next 3 years under the assumption that software costs are capitalized and amortized straight line over the 3 years.
3. Assume that you are a manager for Hidden Code Co. and your compensation package calls for bonuses to be paid in 3 years.
Identify the method of accounting for software R&D you would prefer if bonuses were based on:
i) The level of income?
ii) A fixed multiple of profitability?
Explain your answers to receive credit.
Expert Answer:
YEAR Amount in Million 1 Expected operating income 1 2 3 Sales 120 2 3 Yrs 80 80 80 Operating Exp 75 ... View the full answer
