Question

Economic

Value

Added​)

K.​ Johnson, Inc.'s managers want to evaluate the​ firm's prior-year performance in terms of its contribution to shareholder value. This past​ year, the firm earned an operating income return on investment of

13

​percent, compared to an industry norm of

12

percent. It has been estimated that the​ firm's investors have an opportunity cost on their funds of

16

​percent, which is the same as the​ firm's overall cost of capital. The​ firm's total assets for the year were

$ 250

million. Compute the amount of economic value created or destroyed by the firm. How does your finding support or fail to support what you would conclude using ratio analysis to evaluate the​ firm's performance? Assume that the firm has no debt.

What is the amount of economic value created or destroyed by the​ firm? Enter a positive number for EVA created or a negative number for EVA destroyed.

​$nothing

million  ​(Round to one decimal​ place.)

Does your finding support what you would conclude using ratio analysis to evaluate the​ firm's performance?  ​(Select the best choice​ below.)

A.

Yes. A firm that outperforms the average firm in the industry tends to have a lower or even a negative amount of EVA.

B.

No. The EVA measures only the​ shareholder's wealth and thus can not be used to evaluate the​ firm's performance in ratio analysis.  

C.

Yes. The amount of economic value created or destroyed by the firm is not related to the​ firm's performance when compared to industry norms.

D.

No. The loss of shareholder value occurs in spite of the fact that the firm is earning a return on its investments above the average firm in the industry.

Answer 1

Economic Value added (EVA)=Net Income –(Capital Invested* Cost of capital)

Economic Value added (EVA)=Net Income – Required Income

A	Total Assets of the firm	$250	million
B	Total Debt	$0
C=A-B	Total Equity	$250	million
D	Overall Cost of Capital	16%
E=A*D	Required Income	$40	million
F	Return on investment	12%
G=A*F	Net Income	$30	million
H=G-F	Economic Value Added	($10)	million

Economic value destroyed by the firm=$10 million

Net income as per industry norm=12% of investment

Actual income =13% of investment

Actual income is higher than the industry norm

D.

No. The loss of shareholder value occurs in spite of the fact that the firm is earning a return on its investments above the average firm in the industry.