Question

Springfield Corporation, whose tax rate is 40%, has two sources of funds: long-term debt with a market value of $10,000,000 and an interest rate of 8%, and equity capital with a market value of $10,000,000 and a cost of equity of 13.2%. Springfield uses its weighted average cost of capital to calculate the EVA for its Dallas division. For the latest year, the Dallas division had a NOPAT of $250,000, total assets of $1,000,000 and current liabilities of $200,000. The division’s EVA is:

		$180,000
		$165,200
		$160,000
		$78,000
		$178,000
		$225,000

Answer 1

Notes:1
	WACC: weighted average cost of capital
	Calculation of WACC
	Cost of Debt = (1 - Tax Rate) X Rate of interest
	Cost of Debt = (1 - 0.40) X 8% =	4.80%
	Cost of Equity =	13.20%
	Weight of debt = $ 10,000,000 / $ 20,000,000   = 0.50%
	Weight of Equity = $ 10,000,000 / $ 20,000,000 = 0.50%
Notes:2	Calculation of weighted average cost of Capital
	WACC = (Weight of Debt X Cost of Debt ) X Weight of Equity X Cost of Equity)
	WACC = (0.5 X 4.8% ) + ( 0.5 X 13.2%)
	WACC = 2.4% + 6.6% = 9%
Notes:3
	Calculation of capital Employed
	Capital employed = Total Assets - Current liabilities
	Capital employed = $ 1,000,000 - $ 200,000
	Capital employed = $ 800,000
Solution:
	Economic Value Added = Net Income After tax - (WACC X Capital Employed)
	Economic Value Added =	$             2,50,000	"-"	( 9 % X $ 800,000)
	Economic Value Added =	$             2,50,000	"-"	$                  72,000
	Economic Value Added =	$             1,78,000
	Answer = Option 5 = $ 178,000