Equity investors have contributed $250,000 to your start-up business, while cred
ID: 2620970 • Letter: E
Question
Equity investors have contributed $250,000 to your start-up business, while creditors provided a loan of $300,000. You have calculated your firm’s WACC at 10%. The annual interest payment is $25,000 and the marginal corporate tax rate is 35%. How much profit will your equity holders need to earn in order to break even in economic terms (i.e., EVA of zero)? Equity investors have contributed $250,000 to your start-up business, while creditors provided a loan of $300,000. You have calculated your firm’s WACC at 10%. The annual interest payment is $25,000 and the marginal corporate tax rate is 35%. How much profit will your equity holders need to earn in order to break even in economic terms (i.e., EVA of zero)?Explanation / Answer
Answer ) Economic value added (EVA) = NOPAT – (c × capital) ---------------(1)
where,
c = cost of capital, or the weighted average cost of capital (WACC).
NOPAT =net operating profit after taxes
As per given data ,c= 10% ,
capital = equity + debt = $250,000 +$300,000 = $ 550,000
At break even term , EVA = 0 and use of eq(1)
NOPAT = C* Capital = 10% * $ 550,000 = $ 55,000.
Net operating profit (NOP) = NOPAT / (1-Tax) = $ 55,000 / ( 1 - 0.35) = $84,615.38
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