Question

Calculating EVA

Brewster Company manufactures elderberry wine. Last year, Brewster earned operating income of $186,000 after income taxes. Capital employed equaled $2.9 million. Brewster is 45 percent equity and 55 percent 10-year bonds paying 7 percent interest. Brewster’s marginal tax rate is 40 percent. The company is considered a fairly risky investment and probably commands a 13-point premium above the 5 percent rate on long-term Treasury bonds.

Jonathan Brewster’s aunts, Abby and Martha, have just retired, and Brewster is the new CEO of Brewster Company. He would like to improve EVA for the company. Compute EVA under each of the following independent scenarios that Brewster is considering.

Required:

Use a spreadsheet to perform your calculations and round all interim and percentage figures to four decimal places. If the EVA is negative, enter your answer as a negative amount.

1. No changes are made; calculate EVA using the original data.

$

2. Sugar will be used to replace another natural ingredient (atomic number 33) in the elderberry wine. This should not affect costs but will begin to affect the market assessment of Brewster Company, bringing the premium above long-term Treasury bills to 11 percent the first year and 8 percent the second year. Calculate revised EVA for both years.

	EVA
Year 1	$
Year 2	$

3. Brewster is considering expanding but needs additional capital. The company could borrow money, but it is considering selling more common stock, which would increase equity to 80 percent of total financing. Total capital employed would be $3,200,000. The new after-tax operating income would be $375,000. Using the original data, calculate EVA. Then, recalculate EVA assuming the materials substitution described in Requirement 2. New after-tax income will be $375,000, and in Year 1, the premium will be 11 percent above the long-term Treasury rate. In Year 2, it will be 8 percent above the long-term Treasury rate. (Hint: You will calculate three EVAs for this requirement.)

	EVA
Year 1	$
Year 1 (11% premium)	$
Year 2 (8% premium)	$

Answer 1

Please see below answer relates to EVA ( Economic Value added ) calculation under different situation with help of WACC calculation .  You will Noticed only at last Option with 8% long term base ,, generated +ve EVA of company.

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	Calculate EVA under different Approach
	Brewster Earned Operating Income $ 186000( After tax Income)
	Capital Invested - Employed			29,00,000
	Equity	45%
	Debt	55%
	( 10 year Bond - Paying 7% Interest)
	Margin Tax rate		40%
	Cost of debt ( after Tax )			7%*(1-40%)
	Company probably commands
	a 13 point premium above 5% rate -Long term loan
	Need to calculate Weighted Avg cost of Capital ( WACC)
	WACC	45% *Cost of Equity +55% * cost of Debt
	Cost of Equity		5%+13%
		45%*(5%+13%)+55%*(7%*(1-40%)
	WACC			10.41%
	EVA	Operating Profit After tax $			1,86,000	A
		Capital Employed $			29,00,000
		WACC			10.41%
		WACC calcuatIon on Capital Employed			3,01,890	B
		($2900000*10.41%)
Answer 1		EVA (A-B) $			-1,15,890	( NEGATIVE EVA)
Answer 2		Year 1
		Long Term Treausary Bill to11%
	WACC	45% *Cost of Equity +55% * cost of Debt
	Cost of Equity		5%+11%
		45%*(5%+11%)+55%*(7%*(1-40%)
	WACC	9.51%
	EVA	Operating Profit After tax $			1,86,000	A
		Capital Employed $			29,00,000
		WACC			9.51%
		WACC calculate on Capital Employed			2,75,790	B
		($2900000*9.51%)
		EVA (A-B) $			-89,790	( NEGATIVE EVA)
		Year 2
		Long Term Treasury Bill to 8%
	WACC	45% *Cost of Equity +55% * cost of Debt
	Cost of Equity		5%+8%
		45%*(5%+8%)+55%*(7%*(1-40%)
	WACC	8.16%
	EVA	Operating Profit After tax $			1,86,000	A
		Capital Employed $			29,00,000
		WACC			8.16%
		WACC calculate on Capital Employed			2,36,640	B
		($2900000*8.16%)
		EVA (A-B) $			-50,640	( NEGATIVE EVA)
Answer 3	Year 1	Long Term Treausary Bill to 13%
	WACC	80% *Cost of Equity +20% * cost of Debt
	Cost of Equity		5%+13%
		80%*(5%+13%)+20%*(7%*(1-40%)
	WACC	15.24%
	EVA	Operating Profit After tax $			3,75,000	A
		Capital Employed $			32,00,000
		WACC			15.24%
		WACC calcuate on Capital Employed			4,87,680	B
		($3200000*15.24%)
		EVA (A-B) $			-1,12,680	( NEGATIVE EVA)
	Year 2	Long Term Treausary Bill to 11%
	WACC	80% *Cost of Equity +20% * cost of Debt
	Cost of Equity		5%+11%
		80%*(5%+11%)+20%*(7%*(1-40%)
	WACC	13.64%
	EVA	Operating Profit After tax $			3,75,000	A
		Capital Employed $			32,00,000
		WACC			13.64%
		WACC calcuate on Capital Employed			4,36,480	B
		($3200000*13.64%)
		EVA (A-B) $			-61,480	( NEGATIVE EVA)
	Year 3	Long Term Treausary Bill to 8%
	WACC	80% *Cost of Equity +20% * cost of Debt
	Cost of Equity		5%+8%
		80%*(5%+8%)+20%*(7%*(1-40%)
	WACC	11.24%
	EVA	Operating Profit After tax $			3,75,000	A
		Capital Employed $			32,00,000
		WACC			11.24%
		WACC calcuate on Capital Employed			3,59,680	B
		($3200000*13.64%)
		EVA (A-B) $			15,320	( POSITIVE EVA)