Assume that a particular plant acquires $800,000 of fixed assets with a useful life of four years and no residual value. Straight-line amortization will be used. The plant manager is judged on income in relation to these fixed assets. Annual net income, after deducting amortization, is $80,000.
Assume that sales and all expenses except amortization are on a cash basis.
Dividends equal net income. Thus, cash in the amount of the amortization 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.
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 (assume [unrealistically] that any cash accumulated remains idle)
2. Evaluate the relative merits of gross assets and net book value of assets as investment bases.