Question

Sheila McGrave, a well-known equity analyst for the pharmaceutical industry, has gathered data for Medsonic, Inc., and it is presented in Table 1 below.

Table 1: Data for Medsonic, Inc.
Income statement:
Sales	$7,200,000
- Cash operating expenses	-6,000,000
- Research and development expenses	-250,000
- Depreciation expense	-230,000
EBIT	$720,000
-Interest expense	-120,000
EBT	$600,000
-Taxes	-240,000
Net income	$360,000
Other data:
Current liabilities-non-interest bearing	$1,000,000
Current liabilities-interest bearing	$500,000
Long-term debt	$1,500,000
Common equity	$3,000,000
Total assets	$6,000,000
Tax rate	40.00%
Cost of debt	6.00%
Cost of equity	12.00%
Target debt ratio	0.40

Calculate the following:

(a) NOPAT

(b) WACC

(c) Invested capital

(d) Economic value added (EVA)

Sheila believes Medsonic’s investment in R&D is an investment in an intangible asset whose value should be amortized straight-line over 5 years rather than expensed immediately.Based on Sheila’s assumption, calculate the following:

(e) Adjusted NOPAT

(f) EVA based on adjusted NOPAT

Sheila believes the perpetual growth rate for Medsonic’s EVA is 4.0%. Calculate the following:

(g) Market value added (MVA) using EVA based on adjusted NOPAT

(h) Medsonic’s market value

Answer 1

(a)

Net operating profit after taxes (NOPAT) = Earning before interest and taxes (EBIT) - Taxes

NOPAT = $720000 - $240000

= $480000

(b)

Weighted average cost of capital (WACC) = Total fraction of equity*Cost of equity + Total fraction of debt*Cost of debt

WACC = E*K_{E +} D*K_D*(1-(tax rate/100))

_{Now given,}

_{tax rate = 40%}

d = current interest bearing debt + long term debt

_{= $500000 + $1500000}

_{= $2000000}

_{e = $3000000}

D = d/(d+e) = 0.4

E = e/(d+e) = 0.6

WACC = (0.6*12) + (0.4*6*(1-.40))

= 7.2 + 1.44

= 8.64%

(c)

Invested capital = (shot term debt + long term debt + lease obligations + total equity + total equity equivalents)

= $1000000 + $500000 + $1500000 + $3000000

= $6000000

(d)

Economic value added, EVA = Total assets - current liabilities

= $6000000 - ($1000000 + $500000)

= $4000000