Question

For 2018, Gourmet Kitchen Products reported $22 million of sales and $19 million of operating costs (including depreciation). The company has $15 million of total invested capital. Its after-tax cost of capital is 10%, and its federal-plus-state income tax rate was 36%. What was the firm’s economic value added (EVA), that is, how much value did management add to stockholders’ wealth during 2018?

Answer 1

The firm's Economic Value Added (EVA) for 2018 is $0.42 million, representing the value management added to stockholders’ wealth.

Step-by-step explanation:

To calculate the firm’s Economic Value Added (EVA), we need to follow these steps:

1. Determine the Net Operating Profit After Taxes (NOPAT) by subtracting taxes from the operating profit.
2. Calculate the after-tax Cost of Capital by multiplying the total invested capital by the after-tax cost of capital percentage.
3. Subtract the after-tax Cost of Capital from NOPAT to determine the EVA.

First, let's find NOPAT:

Operating Profit = Sales – Operating Costs = $22 million – $19 million = $3 million.

Taxes on Operating Profit = Operating Profit × Tax Rate = $3 million × 36% = $1.08 million.

NOPAT = Operating Profit – Taxes = $3 million – $1.08 million = $1.92 million.

Now, let's calculate the after-tax Cost of Capital:

After-tax Cost of Capital = Total Invested Capital × After-tax Cost of Capital = $15 million × 10% = $1.5 million.

Finally, we find the EVA:

EVA = NOPAT – After-tax Cost of Capital = $1.92 million – $1.5 million = $0.42 million.

The firm’s EVA is $0.42 million, which indicates that management added that amount to stockholders’ wealth in 2018.

Answer 2

The firm’s economic value added (EVA), that is, how much value did management add to stockholders’ wealth during 2018 is $0.42 million

Step-by-step explanation:

Net operating profit = (22 million - 19 million)*(1 - 0.36)

= $1.92 million

EVA = net operating profit after taxes - invested capital*WACC

= 1.92 million - 15 million*0.10

= $0.42 million

Therefore, The firm’s economic value added (EVA), that is, how much value did management add to stockholders’ wealth during 2018 is $0.42 million