Assignment
Calculating EVA
Brewster company manufactures elderberry wine. Last year, Brewster earned operating income of $192,000 after income taxes. Capital employed equaled $2.3 million. Brewster is 45% equity and 55% 10 yr bonds paying 6% interest. Brewster's marginal tax rate is 40%. The company is considered a fairly risky investment and probably commands a 12-point premium above the 4% rate on long-term Treasury Bonds.
1) No changes are made; calculate EVA using the original data.
2) Sugar will be used to replace another natural ingredient in the elderberry wine. This should not affect costs but will begin to affect the market assessment of Brewster Company, bringing the premium above long-term Treasury bills to 10% the first year and 7% the second year. Calculate revised EVA for both years.
3) Brewster is considering expanding but needs additional capital. the company could borrow money, but it is considering selling more common stock, which would increase equity to 80% of total financing. Total capital employed would be $3,000,000. The new after-tax operating income would be $375,000. Using the original data, calculate the EVA. Then, recalculate EVA assuming the materials substitution described in Requirement 2. New after tax income will be $375,000 and in year 1, the premium will be 10% above the long-term Treasury rate. In year 2, it will be 7% above the long-term Treasury rate.