Question

The results for the last year of Pacham plc are shown below:

	£ ‘000s
Profit before tax and interest	400,000
Interest expense	40,000
Profit before tax	360,000
Tax at 20%	72,000
Profit after tax and interest	288,000

There is no significant difference between economic depreciation and accounting depreciation

Amortisation of goodwill amounted to £2,500,000 in the year. The accumulated amortisation at the beginning of the year was £4,000,000

£900,000,000 capital employed at the start of the year

£120,000 accrued expenses at the start of the year, £200,000 at the end

£1,250,000 provision for doubtful debts at the start of the year, £1,100,000 at the end

The weighted average cost of capital is 7.5%.

Required

Calculate the Economic Value Added, and discuss the aims of the approach and the reasons for the adjustments made.

Answer 1

EVA = Net Operating Profit after tax - [ WACC * Capital Employed]

Calculation of Net Operating Profit after Tax:

Profit before Tax = 360,000,000

(+) Amortisation Exp = 2,500,000

(+) non cash accrued exp = 80,000

(-) Reversal of Provision for doubtful debts = (150,000)

(-) Tax paid = 72,000,000

NOPAT = 434,430,000

EVA = 434,430,000 - [ 900,000,000 * 7.5%]

EVA = $ 366,930,000

All non cash expenditure needs to be added & reversals are deducted from profit before tax.