Question: Residual income and EVA; timing issues. Doorchime Company makes doorbells. It has a weighted-average cost of capital of 6% and total assets of $5,690,000. Doorchime has current liabilities of $550,000. Its operating income for the year was $630,000. Doorchime does not have to pay any income taxes. One of the expenses for accounting purposes was a $70,000 advertising campaign run in early January. The entire amount was deducted this year, although the Doorchime CEO believes the beneficial effects of this advertising will last 4 years.
1. Calculate residual income, assuming Doorchime defines investment as total assets.
2. Calculate EVA for the year. Adjust both the year-end assets and operating income for advertising assuming that for the purposes of economic value added the advertising is capitalized and amortized on a straightline basis over 4 years.
3. Discuss the difference between the outcomes of requirements 1 and 2. Which measure would you recommend, and why?