Question

Here are simplified financial statements for Watervan Corporation. INCOME STATEMENT (Figures in $millions)Net sales $881Cost of goods sold 741Depreciation 31Earnings before interest and taxes (EBIT) $109Interest before tax $97Taxes 34Net income $63 BALANCE SHEET (Figures in $millions) End of Year Start of YearAssetsCurrent assets $369 $312Long-term assets 258 222Total assets $627 $534Liabilities and shareholders; equityCurrent liabilities $194 $157Long-term debt 108 121Shareholders' equity 325 256Total liabilities and shareholders' equity $627 $534The company's cost of capital is 8.5%a. Calculate Watervan's economic value added (EVA). Do not round intermediate calculations. Enter answer in millions rounded 2 decimal places.Economic value added $_____ millionb. What is the company's return on capital? Use start of year rather than average capital. Do not round intermediate calculations. Enter 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 answer as a percent rounded to 2 decimal places.Return on equity _____%

Answer 1

Answer:

1. Economic value added = $34.04 million

2. Company's return on capital = 18.79%

3. Return on equity = 24.61%

Explanation:

1. Economic value added (EVA) = NOPAT - capital charge

Where;

NOPAT = EBIT × ( 1 - tax rate )

Tax rate = Taxes / Income before taxes

= 34 / 97 * 100

= 35%

NOPAT = 109 × ( 1 - 35% )

= 70.85

But,

Capital charge = Capital employed × Cost of capital = (Equity + Interest bearing Liabilities) × Cost of capital

= (325 + 108) × 8.5%

= 433 × 8.5%

= 36.81

Therefore,

Economic value added(EVA)

= 70.85 - 36.81

= $34.04 million

2. Company's return on capital(using start of year equity)

= NOPAT / (Total assets - Current liabilities)

= 70.85 / (534 - 157)

= 70.85 / 377

= 0.1879

= 18.79%

Return on capital is 18.79%

3. Return on equity(using start of year equity) = Net income / Shareholder's equity

= 63 / 256

= 1.125

= 24.61%

Return on equity is 24.61%