Gardenia Co. and Lantana Co. both operate in the same industry. Gardenia began its operations in 20X1 with a $20 million initial investment in plant and equipment with an expected life of 10 years. Lantana’s net asset base is also $20 million, but its assets are, on average, 5 years old with 10-year expected useful lives on January 1, 20X1. Lantana replaces 10% of its assets each year at year-end, while Gardenia, having just entered the industry, does not have immediate plans to replace any assets.
Per year pre-tax net operating cash flow generated $3 million for Gardenia and $5 million for Lantana. Inflation is expected to be 2% per year, and each company expects to keep pace by increasing its pre-tax net operating cash flow by 2% per year. The cost of Lantana’s planned asset replacements will also increase at 2% per year. (Note: For simplicity, assume that prior to 20X1, the replacement cost of Lantana’s assets remained constant.)
Required:
1. Compute return on assets for Gardenia Co. for 20X1 through 20X5.
2. Compute return on assets for Lantana Co. for 20X1 through 20X5.
3. Discuss the differences between your answers to requirement 1 and requirement 2.
