Problem
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.