Question

Assume Division 1 of the XYZ Company had the following results last year. Sales $5,000,000 Operating income 1,000,000 Total assets (average) 10,000,000 Current liabilities 500,000 Management's required rate of return is 8% and the weighted average cost of capital is 6%. Its effective tax rate is 30%. What is the division's economic value added?

Answer 1

Economic Value was $130,000

Step-by-step explanation:

As we know that:

Economic Value Added = Net Operating Income after tax - (WACC * Capital Employed)

Here

Operating Income After Tax is $700,000 (Step1)

WACC is 6%

Capital Employed is $9,500,000 (Step2)

By putting values, we have:

EVA = $700,000 - 9,500,000 * 6%

EVA = $700,000 - $570,000

EVA = $130,000

Step1: Operating Income After Tax

Simply deduct the 30% tax share from the operating income to arise at Net Operating Income After Tax.

Mathematically,

Net Operating Income After Taxes = Operating Income *(1 - Tax Rate)

Here

Operating Income is $1,000,000

Tax Rate is 30%

By putting values, we have:

Net Operating Income After Taxes = $1,000,000 * (1 - 30%)

Net Operating Income After Taxes = $700,000

Step2: Capital Employed

Capital Employed = Total Assets - Current Liabilities

Capital Employed = $10,000,000 - $500,000

Capital Employed = $9,500,000