Page 68 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes Note: This NOPAT calculation does not include the tax savings of debt. Companies paying high
taxes and having high debts may have to consider tax savings effects, but this is perhaps easiest
to do by adding the tax savings component later in the capital cost rate (CCR).
An alternative way to calculate NOPAT:
Net Profit After Tax 210.00
Interest Expenses +200.00
NOPAT 410.00

Step 2: Identify Company’s Capital (C)
Company’s Capital (C) are
Total Liabilities less Non-Interest Bearing Liabilities:
Total Liabilities 2,350.00
less
Accounts Payable (A/P) 100.00
Accrued Expenses (A/E) 250.00
Capital (C) 2,000.00
Step 3: Determine Capital Cost Rate (CCR)
In this example: CCR = 10%
Because, Owners expect 13% return for using their money because less are not attractive to them;
this is about the return that investors can get by investing long-term with equal risk (stocks,
mutual funds, or other companies). Company has 940/2350 = 40% (or 0.4) of equity with a cost
of 13%. Company has also 60% debt and assume that it has to pay 8% interest for it. So the
average capital costs would be:
CCR = Average Equity Proportion × Equity Cost + Average Debt Proportion
Debt cost = 40% × 13% + 60% × 8% = 0.4 × 13% + 0.6 × 8% = 10%
Note: CCR depends on current interest level (interest higher, CCR higher) and company’s
business (company’s business more risky, CCR higher).
Note: If tax savings from interests are included (as they should if we do not want to simplify),
then CCR would be:
CCR = 40% × 13% + 60% × 8% × (1– tax rate) = 0.4 × 13% + 0.6 × 8% × (1 – 0.4) = 8.08% (Using 40%
tax rate)
Step 4: Calculate Company’s EVA
EVA = NOPAT – C × CCR
= 410.00 – 2,000.00 × 0.10
= 210.00
This company created an EVA of 210.
Note: This is the EVA calculation for one year. If a company calculates EVA, e.g., for a quarterly
report (3 months) then it should also calculate capital costs accordingly:
Capital costs for 3 months: 3/12 × 10% × 2,000 = 50
Capital costs for 4 months: 4/12 × 10% × 2,000 = 67
Capital costs for 6 months: 6/12 × 10% × 2,000 = 100
Capital costs for 9 months: 9/12 × 10% × 2,000 = 150

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