14. Biddle Company uses EVA to evaluate the performance of division managers. Fo
ID: 2480870 • Letter: 1
Question
14. Biddle Company uses EVA to evaluate the performance of division managers. For the Wallace Division, after-tax divisional income was $400,000 in year 3. The company adjusts the after-tax income for advertising expenses. First, it adds the annual advertising expenses back to after-tax divisional income. Second, the company managers believe that advertising has a three-year positive effect on the sale of the company’s products, so it amortizes advertising over three years. Advertising expenses in year 1 will be expensed 50 percent, 40 percent in year 2, and 10 percent in year 3. Advertising expenses in year 2 will be expensed 50 percent, 40 percent in year 3, and 10 percent in year 4. Advertising expenses in year 3 will be amortized 50 percent, 40 percent in year 4, and 10 percent in year 5. Third, unamortized advertising expenses become part of the divisional investment in the EVA calculations. Wallace Division had incurred advertising expenses of $100,000 in year 1 and $200,000 in year 2. It incurred $240,000 of advertising in year 3. Before considering the unamortized advertising, the Wallace Division had total assets of $4,200,000 and current liabilities of $600,000 at the beginning of year 3. Biddle Company calculates EVA using the divisional investment at the beginning of the year. The company uses a 12 percent cost of capital to compute EVA.
Required: Compute the EVA for the Wallace Division for year 3
EVA:__________
Explanation / Answer
Formula for: EVA = NOPAT - WACC * K
1) Amortization Schedule of Advertisement Expenses: year year wise amortization incurred Amount 1 2 3 4 5 1 100000 50000 40000 10000 2 200000 100000 80000 20000 3 240000 120000 96000 24000 Yearly amortization 50000 140000 210000 116000 24000 Unamortized expenses in the beginning of the year 110000 (10000 of 1st yr+80000 + 20000of 2nd year) 2) Net assets of Wallace Division at the beginning of the 3rd year: Total assets 4200000 Add: unamortized advt 110000 4310000 Less: current liabilities 600000 3710000 3) Economic Value added for year 3: After tax divisional income 400000 Add: advertising expense for the year 240000 Less: amortization for the year 210000 Divisional income for EVA 430000Formula for: EVA = NOPAT - WACC * K
where k is the economic capital employed WACC is the weighted average cost of capital EVA = 430000 - 3710000*0.12 = -$15,200Related Questions
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