Pharmaceutical firms, oil and gas companies, and other ventures inevitably incur costs on unsuccessful investments in new projects (e.g., new drugs or new wells). For oil and gas firms, a debate continues over whether those costs should be written off as a period expense or capitalized as part of the full cost of finding profitable oil and gas ventures. For pharmaceutical firms, GAAP in the United States is clear that R&D costs are to be expensed when incurred.

Pharm-It has been writing R&D costs off to expense as incurred for both financial reporting and internal performance measurement. However, this year a new management team was hired to improve the profit of Pharm-It's Cardiology Division. The new management team was hired with the provision that it would receive a bonus equal to 10 percent of any profits in excess of base-year profits of the division. However, no bonus would be paid if profits were less than 20 percent of end-of-year investment. The following information was included in the performance report for the division:

	This Year				Base Year				Increase over Base Year
Sales revenues	$	21,500,000			$	21,000,000
Costs incurred
R&D Expense		0				3,800,000
Depreciation and other amortization		3,900,000				3,750,000
Other costs		8,000,000				7,750,000
Division profit	$	9,600,000			$	5,700,000			$	3,900,000
End-of-year investment	$	40,500,000	a		$	34,500,000

^aIncludes other investments not at issue here.

During the year, the new team spent $5 million on R&D activities, of which $4,500,000 was for unsuccessful ventures. The new management team has included the $4,500,000 in the current end-of-year investment base because "You can't invent successful drugs without missing on a few unsuccessful ones."

Required:

a. What is the ROI for the base year and the current year? Ignore taxes.

If R&D is expensed:

Base Year %

Current Year %

b. If R&D is capitalized:

Current Year %