Question

Here are simplified financial statements for Watervan Corporation:

INCOME STATEMENT
(Figures in $ millions)
Net sales	$	892.00
Cost of goods sold		752.00
Depreciation		42.00
Earnings before interest and taxes (EBIT)	$	98.00
Interest expense		23.00
Income before tax	$	75.00
Taxes		15.75
Net income	$	59.25

BALANCE SHEET
(Figures in $ millions)
	End of Year				Start of Year
Assets
Current assets	$	380			$	334
Long-term assets		280				233
Total assets	$	660			$	567
Liabilities and shareholders’ equity
Current liabilities	$	205			$	168
Long-term debt		119				132
Shareholders’ equity		336				267
Total liabilities and shareholders’ equity	$	660			$	567

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 x (1 - tax rate)] - (Cost of capital x invested capital)

= 98 millions x (1 - 0.21) - (8.5% x 660 million)

= 77.42 millions - 56.1 millions

= 21.32 millions

working :- Tax rate = 15.75/75 x 100 = 21%

Invested capital is total assets.

(b) Return on capital = Net income/invested capital

= 59.25/567 x 100 = 10.45%

(c) Retuen on equity = net Income/shareholders equity

= 59.25/267 x 100 = 22.19%

(d) Yes, company is creating value for its shareholders because their return on equity is very high.