Question

17

Given the following data, compute the weighted average cost of capital (WACC).

Components of capital structure                        After Tax Cost

Debt                 $65 million                                          6.5%

Preferred Stock     35 million                                         10.5%             

Common Equity    60 million                                        12.75%

Total                160 million

If the return on assets of the corporation is 13% on an annual basis, calculate its profitability and economic value added, EVA.

Answer 1

Step1: Computation of the weighted average cost of capital(WACC). We have,

Component	Amount(in million)	Component in percentage	Individual cost in Percentage	WACC
Debt	$ 65.00	40.63%	6.5 %	2.64
Preferred Stock	$ 35.00	21.87%	10.5 %	2.30
Common Equity	$ 60.00	37.50%	12.75 %	4..78
Total	$ 160.00			9.72

Hence, the weighted average cost of capital is 9.72%.

Step2: Computation of the profitabiltiy when return on asset is 13%.We have,

Return on Asset = Net Income / Total Asset

Net income = Return on asset x Total asset

Net income = 13% x 160 million = $ 20.8 million

Hence, the profitability is $ 20.8 million.

Step3: Computation of the economic value added(EVA).We have,

EVA = NOPAT - ( WACC X Invested Capital)

Where,

NOPAT = Net Operating profit after taxes = $ 20.8 million

WACC = 9.72 %

Invested capital = $ 160 million

EVA = 20.8 - ( 9.72% X 160) = 20.8 - 15.55 = $ 5.25 Million

Hence,the EVA is $ 5.25 million.