[Anonymous]

I came across this problem on Econcomic Value Added in my review course:

Pretax Operating Profit: $300,000,000

Tax Rate: 40%

Capital Used to Generate Profits 50% debt, 50% equity: $1,200,000,000

Cost of Equity 15%

Cost of Debt 5%

EVA is:

A) $180,000,000

B) $60,000,000

C) $0

D) $120,000,000

I looked up EVA, and Investopedia provided me with this formula: Net Operating Profit After Taxes (NOPAT) – (Capital * Cost of Capital)

With which I arrived at B as my answer. However, my course says the answer should be A, with this explanation:

“The economic value added amount (EVA) is calculated by multiplying the capital

employed at the beginning of the period by the difference between the return on

capital employed (RCOE) and the weighted average cost of capital (WACC). Since a

company is worth its book value if the RCOE is equal to its WACC, the positive

difference between the two would be the percentage by which the value of the

business is increased.

The return on capital employed (RCOE) is a way of measuring the efficiency with

which a company is using its capital to generate revenue. RCOE is the pretax

operating profit divided by the capital employed. For Zig Corp, this would be 0.25,

or 25% ($300,000,000 + $1 ,200,000,000).

The weighted average cost of capital is the weighted average of the cost of debt

and the various equity components of the firm’s capital structure. For Zig Corp,

this weighted average is the sum of the two costs provided in the question, or 20%

(15% + 5%).

RCOE = 300/1200 = 0.25, or 25%

WACC = (Kdebt X Wt.debt) + (Kequity X Wt.equity)

= (0.50 X 0.05) + (0.50 X 0.15)

= .025 + .075 = .100

EVA % = 0.25 – 0.10 = 0.15

EVA= 0.15 x $1.2 billion = $180 million

The tax rate is not pertinent information in this problem.”

I feel like this has happened to me before, where I’ll look up a finance concept and find a definition on the Internet, then apply it only to be presented with a completely different arbitrarily selected method. Am I just crazy, or are there multiple ways of calculating certain ratios? And do I know which ones to use? Thanks for any help, these kinds of questions are confusing and highly frustrating for me.