INCOME STATEMENT
(Figures in $ millions)
Net sales	$ 900.00
Cost of goods sold	760.00
Depreciation	50.00
Earnings before interest and taxes (EBIT)	$ 90.00
Interest expense	31.00
Income before tax	$ 59.00
Taxes	12.39
Net income	$ 46.61
BALANCE SHEET
(Figures in $ millions)
 	End of Year	Start of Year
Assets	 	 
Current assets	$ 388	$ 350
Long-term assets	296	241
Total assets	$ 684	$ 591
Liabilities and shareholders’ equity	 	 
Current liabilities	$ 213	$ 176
Long-term debt	127	140
Shareholders’ equity	344	256
Total liabilities and shareholders’ equity	$ 684	$ 572
The company’s cost of capital is 8.5%.

Required:
Calculate Watervan’s economic value added (EVA).

Note: Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.

What is the company’s return on capital? (Use start-of-year rather than average capital.)

Note: Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.

What is its return on equity? (Use start-of-year rather than average equity.)

Note: Enter your answer as a percent rounded to 2 decimal places.

Is the company creating value for its shareholders?

Let's start by calculating the required metrics.

### 1. Economic Value Added (EVA)
EVA is calculated using the following formula:

\[
\text{EVA} = \text{EBIT} \times (1 - \text{Tax Rate}) - \text{Capital} \times \text{Cost of Capital}
\]

- **EBIT (Earnings Before Interest and Taxes)**: \$90 million
- **Tax Rate**: $\frac{\text{Taxes}}{\text{Income Before Tax}} = \frac{12.39}{59} \approx 0.21$ or 21%
- **Capital**: This is the sum of the company’s debt and equity at the start of the year:
  
  \[
  \text{Capital} = \text{Current Liabilities (Start of Year)} + \text{Long-term Debt (Start of Year)} + \text{Shareholders' Equity (Start of Year)}
  \]
  
  \[
  \text{Capital} = 176 + 140 + 256 = \$572 \text{ million}
  \]
  
- **Cost of Capital**: 8.5%

Now let's calculate EVA:

\[
\text{EVA} = 90 \times (1 - 0.21) - 572 \times 0.085
\]

\[
\text{EVA} = 90 \times 0.79 - 572 \times 0.085
\]

\[
\text{EVA} = 71.1 - 48.62 = 22.48 \text{ million}
\]

### 2. Return on Capital (ROC)
ROC is calculated as:

\[
\text{ROC} = \frac{\text{Net Income}}{\text{Start of Year Capital}} \times 100\%
\]

\[
\text{ROC} = \frac{46.61}{572} \times 100\% \approx 8.15\%
\]

### 3. Return on Equity (ROE)
ROE is calculated as:

\[
\text{ROE} = \frac{\text{Net Income}}{\text{Start of Year Equity}} \times 100\%
\]

\[
\text{ROE} = \frac{46.61}{256} \times 100\% \approx 18.20\%
\]

### 4. Is the Company Creating Value for its Shareholders?
The company creates value for its shareholders if the return on capital exceeds the cost of capital. Here, the return on capital (8.15%) is slightly lower than the cost of capital (8.5%), so the company might not be creating additional value for shareholders according to this metric.

### Summary:
- **EVA**: \$22.48 million
- **Return on Capital**: 8.15%
- **Return on Equity**: 18.20%
- **Value Creation**: The company is likely not creating value for shareholders based on the current figures.

Would you like further details or clarification on any of these calculations?

---

Here are 5 related questions:
1. How would the EVA change if the company's tax rate increased?
2. What impact does a higher cost of capital have on EVA?
3. How does using the average capital (instead of start-of-year capital) affect the ROC calculation?
4. What factors might explain why the company's ROE is significantly higher than its ROC?
5. How could the company improve its EVA and ROC?

**Tip:** Regularly monitoring EVA can help businesses assess whether they are generating returns above their cost of capital, which is crucial for long-term value creation.

Learn how to calculate Watervan’s Economic Value Added (EVA), Return on Capital (ROC), and Return on Equity (ROE) using financial data. Understand the impact of the cost of capital on EVA and assess if the company is creating value for its shareholders. Detailed solutions and calculations provided.

Math Problem Statement

Solution

Ask a new question for Free

By Image

Math Problem Analysis

Mathematical Concepts

Formulas

Theorems

Suitable Grade Level

Related Recommendation