Paula Boothe, president of the Armange Corporation, has mandated a minimum 12% r
ID: 2533565 • Letter: P
Question
Paula Boothe, president of the Armange Corporation, has mandated a minimum 12% return on investment for any project undertaken by the company. Given the company’s decentralization, Paula leaves all investment decisions to the divisional managers as long as they anticipate a minimum rate of return of at least 12%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 12% return on investment for the past three years. This year is not expected to be different from the past three. Koch has just received a proposal to invest $1,830,000 in a new line of energy drinks that is expected to generate $232,000 in operating income. Assume that Armange Corporation’s actual weighted-average cost of capital is 9% and its tax rate is 32%.
Calculate the economic value added of the proposed new line of energy drinks. (If the economic value added is negative then enter with a negative sign preceding the number e.g. -5,125 or parenthesis. e.g. (5,125). Round answer to 0 decimal places, e.g 5,125.)
Paula Boothe, president of the Armange Corporation, has mandated a minimum 12% return on investment for any project undertaken by the company. Given the company’s decentralization, Paula leaves all investment decisions to the divisional managers as long as they anticipate a minimum rate of return of at least 12%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 12% return on investment for the past three years. This year is not expected to be different from the past three. Koch has just received a proposal to invest $1,830,000 in a new line of energy drinks that is expected to generate $232,000 in operating income. Assume that Armange Corporation’s actual weighted-average cost of capital is 9% and its tax rate is 32%.
Explanation / Answer
Economic Value Added of the proposed new line of energy drinks = - $6,940 (Negative)
Economic value added (EVA) = Operating income after tax – Cost of Capital
= [ $2,32,000 (1-0.32)] – [ $18,30,000 x 9%]
= $1,57,760 - $1,64,700
= - $6,940 (Negative EVA)