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Holbrook calculates the NPV of the robotic project and presents his findings to his supervisor, Geoffrey Mans. After reviewing the report, Mans makes the following recommendations:
1 'You forgot to include the $ 100,000 we have spent so far on consultants and project engineers and who knows what else to evaluate the project's feasibility. Rerun the numbers including that amount and get the revised calculations to me this afternoon.'
2. 'Rerun the analysis assuming straight-line depreciation for tax purposes. The NPV will be higher, and we'll be more likely to get the project funded.'
Cummings has two other projects under consideration that would affect the production of storage lockers. Project 1 relates to changing the production process, and Project 2 relates to expanding the distribution facility. Holbrook estimates the NPV of the expected cash flows for Project 1 at negative $7 million. An additional investment of $3 million would allow management to more rapidly adjust to the demand for a certain type of locker. The value of this flexibility is estimated at $9 million. He estimates that the NPV of the expected cash flows for Project 2 at $3 million. An expansion option would require an additional investment of $2 million. At this time, Cummings does not have any capital rationing restrictions.
Holbrook emails the lead analyst for the budgeting group and indicates that he cannot make a decision on Project 2 without knowing the value the expansion option will provide.
Holbrook calls a capital budgeting meeting with CEI's production manager and quality control manager. Holbrook opens the meeting by stating: 'I think we should accept this project based solely on the fact that it provides great operating margins. Nevertheless, I think we should conduct net present value (NPV) analysis to confirm my opinion.' Holbrook then receives the following comments:
Comment 1:
It is important that interest is included in the discounted cash flows used with NPV analysis because interest is a real and very significant expense.
Comment 2:
If applied correctly, the NPV of this project will be higher if we discount economic profits instead of net after-tax operating cash flows in our analysis. I suggest we calculate economic profit as net operating profit after tax minus the dollar cost of capital.
The economic income for year 3 for the robotics project from Exhibit 1 is closest to:

Linda Haas, CFA, follows YD for Gibraltar Capital. Gibraltar Capital prides itself on its thorough fundamental analysis of investment opportunities. The company uses a bottom-up approach to the investment process. Haas's security selection process utilizes residual income models to determine a stock's intrinsic value. Haas obtains YD's 2008 financial statements shown in Exhibit 1. In addition, Haas provides supporting information about YD's financials and other related material found in Exhibit 2.

Haas makes the following statements during her YD presentation to the investment committee.
Statement 1: Based on ROE mean reversion, YD's continuing residual income is assumed to decline to zero over time.
Statement 2: The residual income model states that if YD's ROE equals its equity cost of capital, then YD's intrinsic value will equal its book value per share.
Haas notes that the multi-stage residual equity income model captures more detail in calculating YD's intrinsic value. An assumption of the model is that ROE fades to the cost of equity over time, which is known as a persistence factor (varying from 0 to 1). Identify which characteristic indicates a higher persistence of abnormal earnings.

To get a better understanding of High Plains' financial situation, it is helpful to review High Plains' cash flow statement found in Exhibit 1 and selected financial footnotes found in Exhibit 2.

Exhibit 2: Selected Financial Footnotes
1. During 2008, High Plains' sales increased 27% over 2007. Its sales growth continues to significantly exceed the industry average. Sales are recognized when a firm order is received from the customer, the sales price is fixed and determinable, and collectability is reasonably assured.
2. The cost of inventories is determined using the last-in, first-out (LIFO) method. Had the first-in, first-out method been used, inventories would have been $152 million and $143 million higher as of December 31,2008 and 2007, respectively.
3. Effective January 1, 2008, High Plains changed its depreciation method from the double-declining balance method to the straight-line method in order to be more comparable with the accounting practices of other firms within its industry. The change was not retroactively applied and only affects assets that were acquired on or after January 1,2008.
4. High Plains made the following discretionary expenditures for maintenance and repair of plant and equipment and for advertising and marketing:

5. During the fiscal year ended December 31, 2008, High Plains sold $50 million of its accounts receivable, with recourse, to an unrelated entity. All of the receivables were still outstanding at year end.
6. High Plains conducts some of its operations in facilities leased under noncancelable capital leases. Certain leases include renewal options with provisions for increased lease payments during the renewal term.
7. High Plains' average net operating assets at the end of 2008 and 2007 was $977.89 million and $642.83 million, respectively.
Does High Plains' accounting treatment of its capital leases and receivable sale lower its earnings quality?

For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter-company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.
Assuming International Oilfield is a significantly integrated sales division and virtually all operating, investing, and financing decisions are made by Continental Supply, foreign currency gains and losses that arise from the consolidation of International Oilfield should be reported in: