Question

EVA for a given business unit (investment center) during a given period can be estimated as NOPAT (after-tax cash operating income, less depreciation) ______.

Option 1:
by subtracting the after-tax cash operating income from depreciation.

Option 2:
by adding the after-tax cash operating income to depreciation.

Option 3:
through the division of after-tax cash operating income by depreciation.

Option 4:
by multiplying after-tax cash operating income with depreciation.

Answer 1

EVA is calculated by taking NOPAT and subtracting the product of the cost of capital times the capital employed, not by the methods suggested in the options. To calculate economic profit, both explicit and implicit costs need to be subtracted from total revenues, as demonstrated in the reference material from Chapter 7.

Step-by-step explanation:

The EVA (Economic Value Added) for a given business unit during a given period is not estimated by any of the methods provided in the options. Instead, EVA is calculated by taking the NOPAT (Net Operating Profit After Taxes) and subtracting the product of the cost of capital times the capital employed. Neither subtraction of after-tax cash operating income from depreciation, addition of them, division, nor multiplication of these figures would correctly calculate EVA.

Using information from Chapter 7 as a reference, if we were to calculate economic profit, we would need to subtract both explicit and implicit costs from total revenues. This can be seen in the example where economic profit is calculated as $200,000 (total revenues) minus $85,000 (explicit costs) and then again minus $125,000 (implicit costs) to arrive at a negative economic profit of -$10,000 per year.