Question

(Economic Value Added) Bubble Co. has $10 million in assets that are financed 60 percent by equity and 40 percent by debt. The interest rate on debt is 7 percent while the opportunity cost of equity capital is estimated to be 12 percent. If the operating return on assets is 15 percent calculate if the company creates or destroys the value for shareholders.

What does EVA measure and how should it be interpreted?

Answer 1

Calculation Of Economic Value Added

Opportunity cost of equity capital =12%

Operating return = 15 %

Assets =$ 10 million

Economic Value Added = (Operating return on assets -Cost of equity capital)* Assets

Economic Value Added = (15%-12%)* 10 million

Economic Value Added =$ 0.30 million or $ 300,000

300,000 $ company creates the value for shareholders.

EVA measure shareholder value is created or destroys in firm market value. or

Value created in excess of the required return of the shareholders.

Economic Value Added = (Operating return on assets -Cost of equity capital)* Assets