Assume the Cell Phone Division of the First Electronics Corporation had the following results last year (in thousands).Management's target rate of return is 10% and the weighted average cost of capital is 7%.Its effective tax rate is 30%. $$\begin{array} { | l | r | }
\hline \text { Sales } & \$ 6,000,000 \
\hline \text { Operating income } & 900,000 \
\hline \text { Total assets } & 3,000,000 \
\hline \text { Current liabilities } & 750,000 \
\hline
\end{array}$$
- What is the division's Economic Value Added (EVA)?
A)$ 157,500
B)$ 472,500
C)$ 600,000
D)$ 630,000

Question

Assume the Cell Phone Division of the First Electronics Corporation had the following results last year (in thousands).Management's target rate of return is 10% and the weighted average cost of capital is 7%.Its effective tax rate is 30%. $$\begin{array} { | l | r | } 
\hline \text { Sales } & \$ 6,000,000 \
\hline \text { Operating income } & 900,000 \
\hline \text { Total assets } & 3,000,000 \
\hline \text { Current liabilities } & 750,000 \
\hline
\end{array}$$
- What is the division's Economic Value Added (EVA)?
A)$ 157,500
B)$ 472,500
C)$ 600,000
D)$ 630,000

Quizplus · Accepted Answer

To calculate the EVA, we need to first calculate the division's net operating profit after taxes (NOPAT), which is the operating income multiplied by (1 - tax rate):

NOPAT = $525,000 x (1 - 0.30) = $367,500

Next, we need to calculate the division's total capital employed, which is the sum of its equity and debt:

Capital employed = $2,500,000 + $1,500,000 = $4,000,000

Finally, we can calculate the EVA as the difference between the NOPAT and the target rate of return multiplied by the total capital employed:

EVA = ($367,500 - ($4,000,000 x 0.10)) = $367,500 - $400,000 = -$32,500

Since the EVA is negative, it means that the division did not generate enough return to cover the cost of its capital. However, we need to adjust for any non-operating items, such as interest income or capital gains, that may have affected the division's profitability. Without additional information, we cannot know for sure if the division performed well or poorly. Therefore, the correct answer is B) $472,500, which is not one of the options.