Imagine that you work in the accounting department at the firm and your CEO has just purchased a building and some land

in a basket purchase for $5,000,000. The firm has two appraisals performed, with the first appraisal estimating that the land should have 20% of the purchase price allocated to it, while the second appraisal suggests that 40% of the purchase price should be allocated to it. It is further estimated that the building has a 20-year useful life with a $50,000 salvage value. The CEO’s compensation (more specifically his bonus) is based on firm performance, as measured by return on assets and net income. The board of directors is concerned that the CEO may be opportunistically selecting a depreciation method that will increase his compensation in the near term, as opposed to choosing a depreciation method that more accurately matches the cost of the asset over its revenue producing life.

Prepare a brief memo that answers the following questions that the Board of Directors has raised (conceptual comparisson on all, no numbers) :

1. If the firm choses to use the first appraisal how would that effect return on assets during the first three years of the buildings life relative to if it instead uses the second appraisal?

2. If the firm choses to use straight-line depreciation how would that effect return on assets during the first three years of the buildings life relative to if it instead uses double declining balance?

3. If the firm choses to use straight-line depreciation how would that effect net income in year 4 if the building is sold at the beginning of the 4th year relative to if it instead uses double declining balance?

4. If the firm choses to use straight-line depreciation how would that effect net income in year 21 if the building is sold at the beginning of the 21st year relative to if it instead uses double declining balance?