Having just returned from a stimulating seminar stressing the virtues of Economic Value Added in strategic decision-making, the Vice President of Corporate Development for Venture Telecommunications, Inc., asks his assistant to gather data necessary to calculate last year’s EVA for two company divisions. The Voice Division is home to the company’s traditional businesses, while the Data Division houses the firm’s newer initiatives. Voice is much larger than Data, but Data is growing more rapidly.
The assistant is uncertain about how to best measure the capital devoted to each division but decides to use division assets as reported in the company’s annual report. To estimate each division’s cost of capital, she uses the median cost of capital of several pure-play competitors of each division. The company’s marginal tax rate is 40 percent.
The following table contains the information compiled by the assistant.
| ($ in millions) | |
| Voice Division | Data Division |
Earnings before interest and taxes | $ 220 | $130 |
Division assets | $1,000 | $600 |
Division cost of capital | 10% | 15% |
Within minutes of seeing these figures, the VP Development exclaims, “I knew it. The Data Division is bleeding us dry. I’m going to recommend we dump that division immediately!”
a. Estimate each division’s EVA.
b. Do you agree with the VP Development, should the company immediately eliminate the Data Division? Why or why not?
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