Brewster Company manufactures elderberry wine. Last year,Brewster earned operating income of $193,000 after income taxes.Capital employed equaled $2.9 million. Brewster is 45 percentequity and 55 percent 10-year bonds paying 6 percent interest.Brewster’s marginal tax rate is 40 percent. The company isconsidered a fairly risky investment and probably commands a12-point premium above the 5 percent rate on long-term Treasurybonds.
Required:
Use a spreadsheet to perform your calculations and round allinterim and percentage figures to four decimal places. If the EVAis negative, enter your answer as a negative amount.
1. No changes are made; calculate EVA using theoriginal data.
$ ????
2. Sugar will be used to replace anothernatural ingredient (atomic number 33) in the elderberry wine. Thisshould not affect costs but will begin to affect the marketassessment of Brewster Company, bringing the premium abovelong-term Treasury bills to 10 percent the first year and 7 percentthe second year. Calculate revised EVA for both years.
3. Brewster is considering expanding but needsadditional capital. The company could borrow money, but it isconsidering selling more common stock, which would increase equityto 80 percent of total financing. Total capital employed would be$4,000,000. The new after-tax operating income would be $390,000.Using the original data, calculate EVA. Then, recalculate EVAassuming the materials substitution described in Requirement 2. Newafter-tax income will be $390,000, and in Year 1, the premium willbe 10 percent above the long-term Treasury rate. In Year 2, it willbe 7 percent above the long-term Treasury rate. (Hint: You willcalculate three EVAs for this requirement.)
| EVA |
|
| Year 1 | $ |
| Year 1 (10% premium) | $ |
| Year 2 (7% premium) | $ |
