QUESTION 2 A software developer, Haloon Ltd, starts with a 200,000 initial equity investment on 1 January 2018. Later that day, Haloon receives 60,000 cash from a 4 year bank loan with 6,000 interest payable on 31 December each year. The next day, the company invests 240,000 in computer equipment with a 3 year estimated useful life. In addition, the company pays monthly rent of 1 ,000. Haloon expects to generate cash ows from cash collected from the customers in each of the next four years (i.e., years 2018-2021). Consistent with the usual business life cycle, annual revenues of cash collected from customers are 15,000 in 2018, 100,000 in 2019, 200,000 in 2020, and 30,000 in 2021. The salvage value of the computer equipment is zero when the firm is liquidated by the end of 2021. On 31 December 2021, the bank loan is paid before equity holders receive a liquidating dividend. No dividends are paid in 2018 through 2020. Initially assume that the computer equipment is depreciated using 'straight line' depreciation over the three year period. All cash ows from operating activities are paid out at the end of the year they are earned. The business has a cost of capital of 10% and calculates residual income with capital charges computed based on beginning-oftheyear net book value. Ignore taxes. REQUIRED: (a) i) What are the total cash ows for this investment? What is their net present value (NPV)? (b) (0) (6') ii) Construct projected income statements and balance sheets for each of the four years from 2018 to 2021 inclusive. iii) Without accounting adjustments, what would the residual incomes be for each of the four years from 2018 to 2021 inclusive? iv) What is the net present value of the residual incomes? v) Is there any depreciation schedule that could make economic value added (EVA) constant across all four years? If yes, is this depreciation schedule often observed in practice? [8 marks] How would your answer to question 2(a) have changed if Haloon had no loan, but instead made the bank an equity holder for its 60,000 cash contribution. (Keep everything else the same and the discount rate fixed at 10%.) Explain whether or how taking a loan adds to rm value. [8 marks] How should firms determine their cost of capital charge? Also discuss the following statement: "Our annual incentive plan provides for potential bonus payments to plan participants based upon an economic value added (EVA) performance measure, which rewards return on capital results and focuses on income produced in excess of a "capital charge\" (18% for scal 2017) defined by the Committee. EVA is not recorded until the operating income of the relevant reporting unit surpasses this capital charge hurdle. The Committee believes that the 18% capital charge is a high rate when compared to most companies that use a similar EVA-based compensation program, meaning that significant return occurs for the benefit of the Company (and ultimately shareholders) before executives qualify for annual incentive bonuses.\" Source: Culp, Inc. DEF 14A. [5 marks] When calculating residual income or EVA, rms use book value based on (i) beginning of the fiscal year, (ii) end of the scal year, or (iii) average of the fiscal year. Discuss advantages or disadvantages of each of these methods. Give examples from class materials and discussions. [4 marks]