Question

Here are simplified financial statements for Watervan Corporation:

INCOME STATEMENT
(Figures in $ millions)
Net sales	$	901.00
Cost of goods sold		761.00
Depreciation		51.00
Earnings before interest and taxes (EBIT)	$	89.00
Interest expense		32.00
Income before tax	$	57.00
Taxes		11.97
Net income	$	45.03

BALANCE SHEET
(Figures in $ millions)
	End of Year				Start of Year
Assets
Current assets	$	389			$	352
Long-term assets		298				242
Total assets	$	687			$	594
Liabilities and shareholders’ equity
Current liabilities	$	214			$	177
Long-term debt		128				141
Shareholders’ equity		345				240
Total liabilities and shareholders’ equity	$	687			$	558

The company’s cost of capital is 8.5%.

a. Calculate Watervan’s economic value added (EVA). (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

b. What is the company’s return on capital? (Use start-of-year rather than average capital.) (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

c. What is its return on equity? (Use start-of-year rather than average equity.) (Enter your answer as a percent rounded to 2 decimal places.)

d. Is the company creating value for its shareholders?

Answer 1

a.

EVA = EBIT(1 - Tax%) - (Cost of capital × Total Capitalization)

• Total capitalization = Long term debt + Shareholder's equity

Tax rate = 11.97/57 = 21%

Total capitalization =$(141 + 240) =$ 381 millions

EVA = [(89 × (1 - 21%)) - ( 8.5% ×381)] millions

=$( 70.31 - 32.385) millions

=$ 37.925 millions

=$ 37.93 millions

b.

Return on capital = (EBIT×( 1 - tax%)/(Total Capitalization)

= (89 ×(1 - 21%))/381

= 70.31/ 381

= 0.18454068241

= 0.1845

=18.45%

c.

Return on equity = Net income/Shareholder's equity

= 45.03/240

= 0.187625

= 18.76%

d.

Yes, the company is creating value for its shareholders.

Because the EVA is positive i.e. $ 37.93 millions and ROC and ROE is greater than Cost of capital.