16. accounting versus economic history Ralph has designed a consumer product, and launched a manufacturing and sales organization. To keep the problem uncluttered, the firm has a life of exactly three years. It is incorporated at time t

= 0, with Ralph acquiring all shares for 1, 526.35. (No apologies are offered for this obtuse amount.) You will also notice Ralph lives in a tax-free environment. The interest rate is r = 9%. Subsequent to incorporation, the following cash transactions occur.

t = 0 end yr 1 end yr 2 end yr 3 payment for equipment 1,526.35 materials 200 100 0 labor 300 400 300 misc. factors 200 600 600 customer payments 1,400 1,600 1,500 dividends paid 700 500 600

(a) Determine Ralph’s economic income for each period.

(b) Determine Ralph’s accounting income for each period. You should use straight line depreciation for the equipment, and treat all of the other expenditures as direct cost pools associated with the respective period’s output.

(c) Verify that lifetime income (economic or accounting) equals lifetime cash flow for the firm.

(d) Now assume no dividend is paid until the end of year 3. Any cash on hand is invested at r = 9%. Determine Ralph’s cash flows, economic income for each period, and accounting income for each period. Write a short paragraph detailing your observations.