Question

Question 2 Axis company is a very small company in terms of market capitalisation. The information about this company is given below: Total assets = $200000 Current assets = $45000 Half of the investment is financed by liability and the rest is financed by equity Cost of equity = 12% Cost of debt = 6% Tax rate = 30% Eaming before interest and tax = $250000 a) Calculate the capital charge. b) Calculate the equity charge c) Calculate the economic value added (EVA) d) Compare the EVA with the net income of the company and what does it indicate to a management accountant? [20 marks ]

Answer 1

Answer is given below

Tax Rate Pre Tax Cost 6.0% 12.0% After tax Cost 4.2% 12.0% Debt 30% Equity Amount WACC a &b) Debt Equity Total WACC After tax Cost 4.2% 12.0% 16.2% $100,000 $100,000 $4,200 $12,000 $16,200 Capital Charge Equity Charge $16,200 $12,000 $250,000 Economic Value Added Earnings before tax and interst Less: Less: Taxes @ 30% Net Operating profit after tax Less: Weighted Average Cost of Capital Economic Value added $75,000 $175,000 $16,200 $158,800 $250,000 Net Income Earnings before interest and tax Less: Less: Interest Earnings before tax Less: Taxes @ 30% Net Income $6,000 $244,000 $73,200 $170,800 Net Income Economic Value Added $170,800 $158,800 Net Income is the income computed after deducting expenses and interest and tax expenses EVA on the other hand takes into account the charge on capital deployed in business Hence EVA is more meaningful and indicates whether value addition done in the business