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7. Return on invested capital versus economic value added based bonus systems.
a.
Currently, Fiona’s division generates a 100 percent return on invested capital ($1,000,000 of
NOPAT divided by $1,000,000 of invested capital). If the new project is launched, the division
b.
Currently, Fiona’s division generates an annual economic value added of $800,000 ($1,000,000 of
NOPAT minus a charge for capital equal to 20 percent of $1,000,000 or $200,000). If the new
c.
The important difference between return on invested capital and economic value added is that the
former is a percentage number while the second is a dollar value. Economic value added
8. Economic value added based bonus system.
a.
Formula (1):
Formula (2):
b.
Formula (1):
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Formula (2):
c.
Astra should choose formula (2) since it provides a strong incentive to manage for value creation,
while formula (1) gives none. Note, however, that formula (2) would generate higher
9. Economic value added, market value added, and net present value.
a., b., and c.
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Note that the calculated project’s MVA ($136,006) is equal to its calculated NPV ($136,006). This
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10. Comparison of investment analysis based on cash flows and economic value added.
The project’s cost of capital is:
where kD = 6% is the cost of debt, TC = 30% is the corporate tax rate, and kE = 12% is the cost of
equity. Thus, the project’s cost of capital is:
Project valuation:
(See next page)
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a.
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The net present value of the cash flows from this project at a WACC of 7.32% is equal to
b.
The project’s market value added (MVA) is equal to the present value of its stream of EVAs at a
WACC of 7.32%. It is equal to $36,795, the same as the project’s NPV. Because the project’s
c.
When estimating EVA, invested capital must be measured at the beginning of the period and the
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