Doorwhistle Company makes doorbells. It has a weighted-average cost of capital of 8%, and total assets of $5,690,000. Doorwhistle has current liabilities of $700,000. Its operating income for the year was $649,000. Doorwhistle does not have to pay any income taxes. One of the expenses for accounting purposes was a $100,000 advertising campaign. The entire amount was deducted this year, although the Doorwhistle CEO believes the beneficial effects of this advertising will last four years.
REQUIRED
1. Calculate residual income, assuming Doorwhistle defines investment as total assets.
2. Calculate EVA for the year. Adjust both the assets and operating income for advertising assuming that for the purposes of economic value added the advertising is capitalized and amortized on a straight-line basis over four years.
3. Discuss the difference between the outcomes of requirements 1 and 2 and which measure is preferred.