Problem 14-45 (Algo) Comparing Business Units Using EVA: Solving for the Economic Life of the Investment (LO 14-4)

Colonial Pharmaceuticals is a small firm specializing in new products. It is organized into two divisions, which are based on the products they produce. AC Division is smaller and the life of the products it produces tend to be shorter than those produced by the larger SO Division. Selected financial data for the past year is shown as follows. Divisional investment is as of the beginning of the year. Colonial Pharmaceuticals uses a 9 percent cost of capital and uses beginning-of-the-year investment when computing ROI and residual income. Ignore income taxes.

	AC Division			SO Division
Allocated corp. overhead	$	630		$	1,000
Cost of goods sold		3,260			8,600
Divisional investment		9,600			72,000
R&D		1,875			5,200
Sales		9,200			21,600
SG&A		790			730

R&D is assumed to have a three-year life in the AC Division and a eight-year life in the SO division. All R&D expenditures are spent at the beginning of the year. Assume there are no current liabilities and (unrealistically) that no R&D investments had taken place before this year.

Al, the manager of the AC Division, complains that the calculation of EVA is unfair, because a much longer life is assumed for the SO Division in calculating EVA. Sean, the manager of SO, responds that EVA is supposed to reflect economic reality and that the reality is that R&D investments in SO Division do have a longer life.

Required:

a. Assume that the economic life of R&D investments is three years in the AC Division. What economic life would the R&D investments in the SO Division have to make EVA in the two divisions equal? (Round EVA to 2 decimal places and final answer to 1 decimal places. Do not round intermediate calculations.)

Economic life ? years