Question 3

A division is considering investing in capital equipment costing 1.5m. The useful economic life of the equipment is expected to be 30 years, with no resale value at the end of the period. The forecast return on the initial investment is 20 per cent per annum beforedepreciation. The division's cost of capital is 13 per cent.

Required:

a)Calculate the expected annual residual income of the initial investment?

b)In no more than 600 words, describe the merits and drawbacks of using residual income for measuring divisional managerial and economic performance. Do you believe Eva is better?