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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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EVA For 2016, Gourmet Kitchen Products reported $22 million of sales and $19 million of operating costs (including depredation). The company has $15 million of total invested capital. Its after tax cost of capital is 10%, and its federal-plus-State income tax rate was 36%. What was the firm’s economic value added (EVA), that is, how much value did management add to stockholders’ wealth during 2016?

Summary Introduction

To compute: The economic value added for Company G.

Introduction:

It is a measure along with the market value added, to evaluate management’s performance. It considers the opportunity costs of capital invested in the business and the net operating profit generated by the business.

Explanation

Given,

Net operating income is $3 million (working note).

Income tax rate is 36% or 0.36.

Total invested capital $15 million.

After tax percentage cost of capital is 10% or 0.10.

Formula to compute economic value added,

Economic Value Added=[Operating Income(1Tax Rate)Invested Capital×After Tax Percentage Cost of Capital]

Substitute $3 million for operating income, 0.36 for tax rate, $15 million for invested capital and 0.10 for after tax percentage cost of capital

Economic Value Added=[$3 million(10.36)$15 million×0

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