Exeter Division of Wetherby Labs acquired an asset with a cost of $800,000 and a...

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Accounting

Exeter Division of Wetherby Labs acquired an asset with a cost of $800,000 and a four-year life. The cash flows from the asset, considering the effects of inflation, were scheduled as follows:

Year Cash Flow

1 $ 250,000

2 275,000

3 290,000

4 300,000

The cost of the asset is expected to increase at a rate of 5 percent per year, compounded each year. Performance measures are based on beginning-of-year gross book values for the investment base. Ignore taxes.

Assume that the company uses a 12 percent cost of capital.

Year	Cash Flow
1	$ 250,000
2	275,000
3	290,000
4	300,000

Required:

What is the residual income for each year of the asset's life, using a historical cost approach?

What is the residual income for each year of the asset's life if both the investment base and depreciation are determined by the current cost of the asset at the start of each year?

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