Question

Under the financing approach to estimating EVA, EVA NOPAT is estimated by building up to the rate of return on capital (r) from the standard return on equity (ROE) that is calculated using reported accounting data. Steps include ______.

Option 1: Adjusting for non-operating items and non-cash charges.
Option 2: Subtracting non-recurring expenses from reported accounting data.
Option 3: Adding back interest expense to reported accounting data.
Option 4: Deducting preferred dividends from reported accounting data.

Answer 1

In estimating EVA NOPAT, the process involves adjusting for non-operating items, non-cash charges, and other specific expenses to determine the accurate measure of a company's economic profit based on its operating efficiency.

Step-by-step explanation:

Under the financing approach to estimating Economic Value Added (EVA), NOPAT is estimated by adjusting the rate of return on capital from the standard return on equity (ROE) that is calculated using reported accounting data. The process includes adjusting for non-operating items and non-cash charges, subtracting non-recurring expenses, adding back interest expense, and deducting preferred dividends from reported accounting data.

For example, when calculating the accounting profit, you subtract the explicit costs from the revenue. So, if the revenue is $200,000 and the explicit costs are $85,000, the accounting profit would be $115,000. It's from this accounting profit that you start making adjustments to arrive at NOPAT for EVA calculations. Therefore, you might add back interest expenses, as these are considered financing costs and not operational costs.