Xenold, Inc., manufactures and sells cooktops and ovens through three divisions:

Question

Xenold, Inc., manufactures and sells cooktops and ovens through three divisions: Home, Restaurant, and Specialty. Each division is evaluated as a profit center. Data for each division for last year are as follows (numbers in thousands):

The income tax rate for Xenold, Inc., is 40 percent. Xenold, Inc., has two sources of financing: bonds paying 5 percent interest, which account for 25 percent of total investment, and equity accounting for the remaining 75 percent of total investment. Xenold, Inc., has been in business for over 15 years and is considered a relatively stable stock, despite its link to the cyclical construction industry. As a result, Xenold stock has an opportunity cost of 5 percent over the 4 percent long-term government bond rate. Xenold’s total capital employed is $5.04 million ($2,600,000 for the Home Division, $1,700,000 for the Restaurant Division, and the remainder for the Specialty Division).

1. Calculate Xenold’s weighted average cost of capital. Enter your answer as a decimal value rounded to three places. For example, 4.36% would be entered as ".044". Round your calculations to four decimal places.

2. Calculate EVA for each division and for Xenold, Inc. In your computations, carry the weighted average cost of capital to three decimal places. If the EVA is negative, enter your answer as a negative amount.

Explanation / Answer

1. weighted average cost of capital = (W1 x Cost of Debt + w2 x cost of equity) (w1 + w2)

Cost of Debt = (1-tax) x Interest on Bond

= ( 1- 40% ) x 5%

= 3%

cost of Equity is given as 9% ( 5% over 4% bond)

now weighted average cost of capital = 25% x 3% + 9% x 75% ( where 25% is weight of Debt)

= 7.5%

2. Calculation of EVA

EVA = NOPAT – (k x capital)

Where: NOPAT = Net operating profits after tax., k = weighted cost of capital

following is the calculation

Particulars Home Restaurant Specialty Sales 41,40,000 36,00,000 25,20,000 Cost of good sold 29,00,000 26,40,000 17,00,000 Selling & distribution exp 9,50,000 4,10,000 3,20,000 Profit before tax 2,90,000 5,50,000 5,00,000 Tax @40% 1,16,000 2,20,000 2,00,000 NOPAT (A) 1,74,000 3,30,000 3,00,000 Avg Capital Employed 26,00,000 17,00,000 7,40,000 Cost of capital ( B) 1,95,000 1,27,500 55,500 (NOPAT x k) i.e k= 7.5% Economic Value Added ( A - B) -21,000 2,02,500 2,44,500

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