Question

Biddle Company uses EVA to evaluate the performance of division managers. For the Wallace Division, after-tax divisional income was $630,000 in year 3. The company adjusts the after-tax income for advertising expenses. First, it adds the annual advertising expenses back to after-tax divisional Income. Second, the company managers believe that advertising has a three-year positive effect on the sale of the company's products, so it amortizes advertising over three years. Advertising expenses in year 1 will be expensed 60 percent, 30 percent in year 2, and 10 percent in year 3. Advertising expenses in year 2 will be expensed 60 percent, 30 percent in year 3, and 10 percent in year 4. Advertising expenses in year 3 will be amortized 60 percent, 30 percent in year 4, and 10 percent in year 5. Third unamortized advertising expenses become part of the divisional investment in the EVA calculations. Wallace Division incurred advertising expenses of $162,000 in year 1 and $312.000 in year 2. It incurred $372,000 of advertising in year 3. Before considering the unamortized advertising, the Wallace Division had total assets of $6,600,000 and current liabilities of $960,000 at the beginning of year 3. Biddle Company calculates EVA using the divisional investment at the beginning of the year. The company uses a 10 percent cost of capital to compute EVA Required: Compute the EVA for the Wallace Division for year 3. Answer is complete but not entirely correct. Adjusted divisional income Cost of adjusted divisional investment Economic Value Added (EVA) 063.000 5.620,000 381,000

Answer 1

	Year 1	Year 2	Year 3	Unamortized
Advertisment expense	$162000	$312000	$372000
Apportionment of year 1 advertisement expense	$97200	$48600	$16200
Apportionment of year 2 advertisement expense		$187200	$93600	$31200
Apportionment of year 3 advertisement expense			$223200	$148800
Total	$97200	$235800	$333000	$180000
After tax income for year 3			$630000
Adjusted divisional income			$963000
Total asset at the beginning of year 3	$6600000
Less: current liabilities	$960000
Investment at the beginning of year 3	$5640000
Add : unamortized advertisement expense	$180000
Cost of adjusted divisional investment	$5820000
EVA
Net operating profit after tax - (capital invested *WACC)
$963000 - $5820000*10%
$963000-$582000
$381000