Question

In the financing approach to estimating EVA, the return on capital (r) is estimated by ______.

Option 1:
Dividing NOPAT by average total assets.

Option 2:
Dividing net income by average equity.

Option 3:
Adding interest expense to net income.

Option 4:
Subtracting taxes from net income.

Answer 1

The financing approach for estimating EVA involves dividing NOPAT by average total assets. Understanding this return on capital is crucial for firms to make informed investment decisions and evaluate value creation.

Step-by-step explanation:

In the financing approach to estimating Economic Value Added (EVA), the return on capital (r) is estimated by dividing Net Operating Profit After Tax (NOPAT) by average total assets. This is known as Option 1. This approach helps firms in evaluating their decisions on spending money now and expecting to earn profits in the future, such as investing in machinery, plants, or research and development. To raise financial capital for these investments, firms can opt for early-stage investors, reinvest profits, borrow through banks or bonds, or by selling stock. Understanding the return on invested capital is crucial for these firms to make informed investment decisions and to determine whether they are creating value beyond the cost of capital.