Question: Use of Gross or Net Book Value of Fixed Assets Assume that a machine shop acquires $520,000 of fixed assets with a useful life of 4 years and no residual value. The shop uses straight-line depreciation. The company judges the shop manager based on income in relation to these fixed assets. Annual net income, after deducting depreciation, is $20,000. Assume that sales, and all expenses except depreciation, are on a cash basis. Dividends equal net income. Thus, cash in the amount of the depreciation charge will accumulate each year. The plant manager's performance is judged in relation to fixed assets because all current assets, including cash, are considered under central-company control. Assume (unrealistically) that any cash accumulated remains idle. Ignore taxes.
1. Prepare a comparative tabulation of the plant's rate of return and the company's overall rate of return based on
a. gross (i.e., original cost) assets.
b. net book value of assets.
2. Evaluate the relative merits of gross assets and net book value of assets as investment bases.