Upper Division of Lower Company acquired an asset with a cost of $600,000 and a four-year life. The cash flows from the asset, considering the effects of inflation, were scheduled as follows:
Year Cash Flow
1 . . . . . . . . . . . . . . . . . . . . . . . . . . . $225,000
2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255,000
3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285,000
4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000
The cost of the asset is expected to increase at a rate of 10 percent per year, compounded each year. Performance measures are based on beginning-of-year gross book values for the investment base. Ignore taxes.
Required
a. What is the ROI for each year of the asset’s life, using a historical cost approach?
b. What is the ROI for each year of the asset’s life if both the investment base and depreciation are determined by the current cost of the asset at the start of each year?