Backhaus Beer Brewers (BBB) just announced that the current fiscal year\'s incom
ID: 2667410 • Letter: B
Question
Backhaus Beer Brewers (BBB) just announced that the current fiscal year's income statement reports its net income to be $1.2 million. BBB's marginal tax rate is 40 percent, and its interest expense for the year was $1.5 million. The company has $8.0 million of invested capital, of which 60 percent is debt. In addition, BBB tries to maintain a weighted average cost of capital (WACC) near 12 percent.A) Compute the operating income (EBIT) that BBB earned in the current year
B) What is BBB's economic value added (EVA) for the current year?
C) BBB has 500,000 shares of common stock outstanding. According to the EVA value you computed in question B, how much can BBB pay in dividends per share before the value of the firm would start to decrease? If BBB doesn't pay any dividends, what would you expect to happen to the value of the firm?
Explanation / Answer
a) Computing the EBIT using the information We know that net income is obtained as Net income = EBT (1-Tax rate) where EBT is the Earnings before interest. Substituting the values in the above equation, we get $1,200,000 = EBT (1 - 0.40) $1,200,000 = EBT (0.60) EBT = $1,200,000 / 0.60 = $2,000,000 Therefore, the value of EBT is $2,000,000 Calculating the value of EBIT using EBT: EBT = EBIT - Interest expense where EBIT is the Earnings before interest and expense $2,000,000 = EBIT - $1,500,000 EBIT = $2,000,000 + $1,500,000 = $3,500,000 Therefore, the value of EBIT is $3,500,000 b) CAlculating the EVA for the Current year: The formula for calculating the EVA is EVA = NOPAT - (Invested capital * Cost of capital) But NOPAT is Net operating profit after tax which is calculated as NOPAT = Operating income or (EBIT) (1 - Tax rate) = $3,500,000 (1 - 0.40) = $3,500,000 (0.60) = $2,100,000 Therefore, the value of NOPAT is $2,100,000 Substituting the value of NOPAT in the EVA formula, we get EVA = $2,100,000 - ($8,000,000 * 0.12) = $2,100,000 - $960,000 = $1,140,000 Therefore, the value of EVA is $1,140,000 c) Calculating the Earning per share of common stock: EPS = Net income / Shares of common stock outsanding = $1,200,000 / 500,000 = $2.4 per share Therefore, the EPS of common stock is $2.4 Since the EPS is $2.4, the maximu dividend that can be paid is $2.4 per share. But if companyy distributes any dividends then the market value of the firm decreases since there will be no retained earnings for future growth. And if the company decides not to distribute any dividends, then the value of the firm will be at the highest level.Related Questions
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