[Determined CPA]

I’m doing the Wiley questions, I didn’t see this question in becker but I might have missed it. I think this question is a good question to review because it addresses EVA, cost of capital and just seems to be a good comprehensive question, so I figured id share!

Good luck!

Zig Corp. provides the following information:

Pretax operating profit $300,000,000

Tax rate 40%

Capital used to generate profits 50% debt, 50% equity $1,200,000,000

Cost of equity 15%

Cost of debt 5%

What of the following represent Zig’s year-end economic value-added amount?

$0

$60,000,000

$120,000,000

$180,000,000

Answer is $60,000,000

This answer is correct. The requirement is to calculate the year-end economic value-added (EVA) amount. EVA is equal to net operating profit after taxes minus the after-tax weighted-average cost of capital multiplied by invested capital. In this case, net operating profit after taxes is equal to $180,000,000 [$300,000,000 – (40% × $300,000,000)]. The weighted-average cost of capital is equal to 10% [(15% + 5%) ÷ 2]. EVA is equal to $180,000,000 – (10% × $1,200,000,000) = $60,000,000.

A - 75
B - 78 God is good.
F - 77 Answered prayers.
R - 84! Done!!

Paperwork sent - waiting for license!!
Still on a cloud and in shock. Through God, all things will happen.

[scarletknight91]

Determined CPA, 95% sure this was in becker and just to clarify, the cost of debt should be labeled as after -tax cost of debt. otherwise, the answer would be 72,000,000 if cost of debt was pre tax.

FAR: PASSED
REG: PASSED
AUD: PASSED
BEC: PASSED

DONE

[scarletknight91]

Determined CPA, 95% sure this was in becker and just to clarify, the cost of debt should be labeled as after -tax cost of debt. otherwise, the answer would be 72,000,000 if cost of debt was pre tax.

FAR: PASSED
REG: PASSED
AUD: PASSED
BEC: PASSED

DONE

[Determined CPA]

Agreed, scarlet! Luckily that wasn't an answer choice.

A - 75
B - 78 God is good.
F - 77 Answered prayers.
R - 84! Done!!

Paperwork sent - waiting for license!!
Still on a cloud and in shock. Through God, all things will happen.

[Determined CPA]

Agreed, scarlet! Luckily that wasn't an answer choice.

A - 75
B - 78 God is good.
F - 77 Answered prayers.
R - 84! Done!!

Paperwork sent - waiting for license!!
Still on a cloud and in shock. Through God, all things will happen.

[newnc]

Thanks for sharing!

BEC-75(expired), 74 5/24/14
REG-64

[newnc]

Thanks for sharing!

BEC-75(expired), 74 5/24/14
REG-64

[newnc]

I just encountered this question in the NINJA MCQ and the answer is different. Take a look and let me know if I'm confused.

Zig Corp. provides the following information:

Pretax operating profit $300,000,000

Tax rate 40%

Capital used to generate profits 50% debt, 50% equity $1,200,000,000

Cost of equity 15%

Cost of debt 5%

What of the following represents Zig's year-end economic value added amount?

A.

$0

B.

$60,000,000

C.

$120,000,000

D.

$180,000,000

Answer: D

The economic value added amount (EVA) is calculated by multiplying the capital employed at the beginning of the period by the difference between the return on capital employed (RCOE) and the weighted average cost of capital (WACC). Since a company is worth its book value if the RCOE is equal to its WACC, the positive difference between the two would be the percentage by which the value of the business is increased.

The return on capital employed (RCOE) is a way of measuring the efficiency with which a company is using its capital to generate revenue. RCOE is the pretax operating profit divided by the capital employed. For Zig Corp, this would be 0.25, or 25% ($300,000,000 ÷ $1,200,000,000).

The weighted average cost of capital is the weighted average of the cost of debt and the various equity components of the firm's capital structure. For Zig Corp, this weighted average is the sum of the two costs provided in the question, or 20% (15% + 5%).

RCOE = 300/1200 = 0.25, or 25%

WACC = (Kdebt x Wt.debt) + (Kequity x Wt.equity)

= (0.50 x 0.05) + (0.50 x 0.15)

= .025 + .075 = .100

EVA % = 0.25 – 0.10 = 0.15

EVA = 0.15 x $1.2 billion = $180 million

The tax rate is not pertinent information in this problem.

BEC-75(expired), 74 5/24/14
REG-64

[newnc]

I just encountered this question in the NINJA MCQ and the answer is different. Take a look and let me know if I'm confused.

Zig Corp. provides the following information:

Pretax operating profit $300,000,000

Tax rate 40%

Capital used to generate profits 50% debt, 50% equity $1,200,000,000

Cost of equity 15%

Cost of debt 5%

What of the following represents Zig's year-end economic value added amount?

A.

$0

B.

$60,000,000

C.

$120,000,000

D.

$180,000,000

Answer: D

The economic value added amount (EVA) is calculated by multiplying the capital employed at the beginning of the period by the difference between the return on capital employed (RCOE) and the weighted average cost of capital (WACC). Since a company is worth its book value if the RCOE is equal to its WACC, the positive difference between the two would be the percentage by which the value of the business is increased.

The return on capital employed (RCOE) is a way of measuring the efficiency with which a company is using its capital to generate revenue. RCOE is the pretax operating profit divided by the capital employed. For Zig Corp, this would be 0.25, or 25% ($300,000,000 ÷ $1,200,000,000).

The weighted average cost of capital is the weighted average of the cost of debt and the various equity components of the firm's capital structure. For Zig Corp, this weighted average is the sum of the two costs provided in the question, or 20% (15% + 5%).

RCOE = 300/1200 = 0.25, or 25%

WACC = (Kdebt x Wt.debt) + (Kequity x Wt.equity)

= (0.50 x 0.05) + (0.50 x 0.15)

= .025 + .075 = .100

EVA % = 0.25 – 0.10 = 0.15

EVA = 0.15 x $1.2 billion = $180 million

The tax rate is not pertinent information in this problem.

BEC-75(expired), 74 5/24/14
REG-64

[Determined CPA]

oh no. Now what?!

A - 75
B - 78 God is good.
F - 77 Answered prayers.
R - 84! Done!!

Paperwork sent - waiting for license!!
Still on a cloud and in shock. Through God, all things will happen.

[Determined CPA]

oh no. Now what?!

A - 75
B - 78 God is good.
F - 77 Answered prayers.
R - 84! Done!!

Paperwork sent - waiting for license!!
Still on a cloud and in shock. Through God, all things will happen.

[fsuMAcc]

The weighted average cost of capital is the weighted average of the cost of debt and the various equity components of the firm's capital structure. For Zig Corp, this weighted average is the sum of the two costs provided in the question, or 20% (15% + 5%).

^^ This part is wrong. The WACC isn't the sum of the cost of debt and equity, it's the sum of those costs weighted by the proportion of each in the overall capital financing. The WACC in this problem is 10%, and even though the Ninja method is different from how I'd do it, replacing the 20% with 10% gets the correct answer of 60,000.

[fsuMAcc]

The weighted average cost of capital is the weighted average of the cost of debt and the various equity components of the firm's capital structure. For Zig Corp, this weighted average is the sum of the two costs provided in the question, or 20% (15% + 5%).

^^ This part is wrong. The WACC isn't the sum of the cost of debt and equity, it's the sum of those costs weighted by the proportion of each in the overall capital financing. The WACC in this problem is 10%, and even though the Ninja method is different from how I'd do it, replacing the 20% with 10% gets the correct answer of 60,000.

[newnc]

@fsuMAcc- the NINJA method gave a different answer, D. I'm going to ignore it because my test is tomorrow but I'd like to know what the real answer is. I bet it's NINJA's..:)

BEC-75(expired), 74 5/24/14
REG-64

[newnc]

@fsuMAcc- the NINJA method gave a different answer, D. I'm going to ignore it because my test is tomorrow but I'd like to know what the real answer is. I bet it's NINJA's..:)

BEC-75(expired), 74 5/24/14
REG-64

[Author]

Replies