Question

1. Calculating EVA

   Brewster Company manufactures elderberry wine. Last year, Brewster earned operating income of $188,000 after income taxes. Capital employed equaled $2.3 million. Brewster is 40 percent equity and 60 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 12-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 10 percent the first year and 7 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 70 percent of total financing. Total capital employed would be $3,200,000. The new after-tax operating income would be $400,000. Using the original data, calculate EVA. Then, recalculate EVA assuming the materials substitution described in Requirement 2. New after-tax income will be $400,000, and in Year 1, the premium will be 10 percent above the long-term Treasury rate. In Year 2, it will be 7 percent above the long-term Treasury rate. (Hint: You will calculate three EVAs for this requirement.)

   	EVA
   Year 1	$
   Year 1 (10% premium)	$
   Year 2 (7% premium)	$

Answer 1

Jolution - Brecaster earned operating fricome $ 188,000 Capital employed equaled $2.3 million Brewstey is Hoy eauity & 60 % 10-year bonds paying 77. intereste Marginal tax rate is hone : Commands a 12-point premiom above the 5 y, yate on long-term. The value of Evd is determined to EVA - operating income after Taxes - weighted average cost of capital* Capital Employed weighted average cost of Capital 'cot of Debe * After tax Cost of Debt + weight of courity e cost of ecourity. => 6002. *77.*(1-40°.) + Lov.* (12::57.) y 60%*77*0.6 + 40%* 0.126 = 7.56%. EVA = $.188,000 - 7.567. *(2,300,000) => $ 188,000 - 173,880 thai, 20 .

Carcorating the revised weighted average cost weight average Cosi of capital [year 1} · => 604 7%* (-402.) + 40.* (10451.) .--) 604.34.*(0.6)+40v (1005) - 4.22% EVA (year 1) = $ 188,000 - 4.22.7.**2,300,000.) : :$ 188.000 - 93060 90,940 weighted average cost of capital (year 2) = 604.877. * (1-404. ) + 40x*(12+54.) -> 604.* 74.* (016) 4. nov" 0.0735). » Sold it. EVA [year2] => 188,000 - Someby. * (2.300.000) - 188,000- 125,580 -7) 125,580 ::

Tabular Representation ;- EVA 90,940 Year 1 125,580 Year 2 Calculating the revised weighted average cost of Capital under each situation : weighted average cost of capital - 30v. v(1-402.) + 70%*(12.9.457.) hoy * ( 0.126 ) 0.6 + 707. 0125) 307.77. - 10.08% . EVA Crear 1]. - increase eauity to 70% of total financing Total Capital employed would be $ 3,200.000 new-after-tax operating income would be $40,0000 EVA = $ 100.000 - 10.084. * (3,200,000) : $ 77,410

weight Average cost of capital seag I lov. premicom) U - 304.* 9.4.*(1-404.5+ 704* (10+57.) - 7.364. EVA year I (10% premiom) = . } 400,000 - 7.364.$ 3,200,000) = $164,480 Weight- average cost of Capital Year 2 ( 77. premioma *30,*74.*(1-MOV.)+707. * (74 +57.) = 6.407. : : VA Yeay 2[24. premium ) - 100,000 - 6-40% (3,200,000) . 195,200 Tabular representation! Year 1 year1 (04. premium) $ 97,440 $164,480 $ 195,200 Year 2. (premium)