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Problem
Suwon Pharmaceuticals invests heavily in research and development (R&D), although it must currently treat its R&D expenditures as expenses for financial accounting purposes. To encourage investment in R&D, Suwon evaluates its division managers using EVA. The company adjusts accounting income for R&D expenditures by assuming these expenditures create assets with a two year life. That is, the R&D expenditures are capitalized and then amortized over two years.
BK division of Suwon shows after-tax income of $2.5 million for year 2. R&D expenditures in year 1 amounted to $1 million and in year 2, R&D expenditures were $1.6 million. For purposes of computing EVA, Suwon assumes all R&D expenditures are made at the beginning of the year. Before adjusting for R&D, BK division shows assets of $10 million at the beginning of year 2 and current liabilities of $200,000. Suwon computes EVA using divisional investment at the beginning of the year and a 12 percent cost of capital.
Required:
Compute EVA for BK division for year 2. (Enter your answers in dollars and not in millions of dollars.)
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