Question

The table below shows a condensed income statement and balance sheet for Androscoggin Copper’s Rumford smelting plant (figures in $ millions). Assume the cost of capital is 10%.

Income Statement for 2018				Assets, December 31, 2018
Revenue	$	57.26		Net working capital	$	7.02
Raw materials cost		18.66
Operating cost		21.03		Investment in plant and equipment		69.93
Depreciation		4.44		Less accumulated depreciation		21.07
Pretax income	$	13.13		Net plant and equipment	$	48.86
Tax at 21%		2.76
Net income	$	10.37		Total assets	$	55.88

a. Calculate the plant’s EVA. (Enter your answer in millions rounded to 2 decimal places.)

Answer: 4.78

b. As the table above shows, the plant is carried on Androscoggin’s books at $48.86 million. However, it is a modern design, and could be sold to another copper company for $101 million. How should this fact change your calculation of EVA? (Negative answers should be indicated by a minus sign. Enter your answer in millions rounded to 2 decimal places.)

Answer 1

Answer to (A):

The Plant's EVA is calculated as follows:

Plant's EVA=Net Income-(Cost of Capital*Investment)

As given in the question: Net Income= $ 10.37 Millions,Cost of Capital =10% and Investment= $ 55.88 Millions

Putting these values into the above formula we get:

Plant's EVA= $ 10.37-(10% *$55.88) ie. $ 4.78 Millions

Answer to (B):

Net Value of the Plant as given in the books= Total Assets-Plant's Book Value.As given in the question: Total Assets= $ 55.88 , Plant's Book Value= $ 48.86 . So putting these values into the formula we get:Net Value of the Plant as given in the books= $ 55.88-$ 48.86 ie. $7.02.

But the market value of the Plant is $ 101 millions as given in the question.

So the value of the investment after incorporating the market value is: Net Value of the Plant as given in the Books +Market Value ie. $7.02+ $101 ie. $108.02 Millions.

Substituting this value , the value of Net Income and the cost of capital in the formula given in part (1) we get:

Plant's EVA= $10.37-(10%* $108.02) ie. -$0.432 Millions

Incorporating the market value of any asset (in this case the plant) helps in reflecting the real opportunity cost of capital.

Note: Investments in this case implies the capital put by the investors in the firm and the cost of capital implies the return expected by the investor .Also as we know that since the asset side  will be equal to the liabilities side therefore the total assets is taken as the investment .