Here are simplified financial statements for Watervan Corporation: INCOME STATEM

Question

Here are simplified financial statements for Watervan Corporation: INCOME STATEMENT (Figures in $ millions) Net sales $ 889 Cost of goods sold 749 Depreciation 39 Earnings before interest and taxes (EBIT) $ 101 Interest expense 20 Income before tax $ 81 Taxes 26 Net income $ 55 BALANCE SHEET (Figures in $ millions) End of Year Start of Year Assets Current assets $ 377 $ 328 Long-term assets 274 230 Total assets $ 651 $ 558 Liabilities and shareholders’ equity Current liabilities $ 202 $ 165 Long-term debt 116 129 Shareholders’ equity 333 264 Total liabilities and shareholders’ equity $ 651 $ 558 The company’s cost of capital is 7.50%. a. Calculate Watervan’s economic value added (EVA). (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) Economic value added $ million b. What is the company’s return on capital? (Use start-of-year rather than average capital.) (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Return on capital % c. What is its return on equity? (Use start-of-year rather than average equity.) (Enter your answer as a percent rounded to 2 decimal places.) Return on equity % d. Is the company creating value for its shareholders? Yes No

Explanation / Answer

a) the economic value added is the incremental difference ìn the rate of return over the company's cost of capital. the formaula to caluculate the economic value added is Net investment *(actual return on investment -percentage cost of capital) there is one more formula to caluclate the economic value added which we will be using = Net operating profit after tax (NOPAT)-(capital*cost of capital)

hence NOPAT = operating income *(1-tax rate )

=tax rate = tax/income before tax = 26/81 = 32.09%

NOPAT = income before interest and tax (1-32.09%)

= 101*(.6791)

$68.58million is the economic value added.

b) To compute the return on capital = NOPAT /invested capital in the beginning

= Invested capital = Fixed asset +intangible+current asset - current liabilities - cash

= 274+0+377-202 = $ 449 Million

ROC = 101/449 = 22.5%

c) Return on equity = net income /shareholders equity

= 55/264 = 20.83%

d) the company is actually not creating any value to the shareholder because the return on capital is motre than the return on equity and hence shareholders value is not increased.

Related Questions

Navigate

• Browse (All)
• Browse H
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.