Question 1

The following are advantages of using EVA as a performance measure except

Accepted Answer

This statement is incorrect. EVA does measure present values by deducting the cost of capital from the net operating profit after tax (NOPAT). This helps to determine the overall economic value added by a business or unit. The other three statements are advantages of EVA.

Question 2

Which of the following is NOT an advantage to calculating and reporting economic depreciation?

Accepted Answer

Economic depreciation can be complex and difficult to calculate accurately because it requires estimating the current market value of an asset and its expected useful life, which can be more challenging than applying standard accounting depreciation methods.

Question 3

A firm has an average investment of $10,000 during the year. During the same period, the firm generates after-tax income of $1,000.
Calculate the economic value added (EVA)for the firm. (The cost of capital is 15 percent.)

Accepted Answer

Economic Value Added (EVA) is calculated as EVA = NOPAT - (WACC * Capital), where NOPAT is net operating profit after tax, WACC is the weighted average cost of capital, and Capital is the amount of capital invested. In this case, NOPAT is $1,000, WACC is 15%, and Capital is $10,000. Thus, EVA = $1,000 - (0.15 * $10,000) = $1,000 - $1,500 = -$500.

Question 4

Which type of situation best represents "gambling for redemption"?

Accepted Answer

Gambling for redemption involves taking a high-risk decision in order to save oneself from a dire situation. In option D, the firm on the verge of bankruptcy invests all available funds in a high-risk project with a low NPV in an attempt to save itself, which represents gambling for redemption. Options A, B, and C do not involve a similar high-risk decision to save oneself from a dire situation.

Question 5

The term economic value added (EVA)is trademarked by

Accepted Answer

The term economic value added (EVA) is trademarked by Stern-Stewart.

Question 6

A firm has an average investment of $10,000 during the year. During the same time, the firm generates after-tax income of $2,000.
Calculate the economic value added (EVA)for the firm. (The cost of capital is 15 percent.)

Accepted Answer

EVA = Net income after taxes - (Cost of capital * Average investment)EVA = $2,000 - (0.15 * $10,000)EVA = $2,000 - $1,500EVA = $500

Question 7

Which of the following statements is not true?

Accepted Answer

EVA (Economic Value Added) is consistent with DCF (Discounted Cash Flow) as both are methods used to assess the value created by a project or investment.

Question 8

One calculates economic value added (EVA)as follows:

Accepted Answer

Economic value added (EVA) is calculated as the difference between the company's net operating profit after tax (NOPAT) and the cost of capital. The cost of capital includes both the cost of debt and the cost of equity, weighted according to their share in the company's capital structure. Therefore, option C, which calculates EVA as income earned minus (cost of capital) × (investment), is the best choice.

Question 9

One calculates EVA as follows:

Accepted Answer

EVA (Economic Value Added) is calculated by subtracting the cost of capital (r) from the return on investment (ROI) and then multiplying that result by the capital invested. Therefore, the correct formula is EVA = (ROI - r) x (capital invested).

Question 10

A firm has an average investment of $10,000 during the year. During the same period, the firm generates after-tax income of $1,000. If the cost of capital is 15 percent, what is the net return on the investment?

Accepted Answer

The net return on investment is calculated by subtracting the cost of capital from the return on investment. The return on investment is $1,000/$10,000 = 10%. Subtracting the cost of capital (15%) from this gives a net return of -5%.

Question 11

Generally, firms with high levels of intangible assets tend to report (all else equal)

Accepted Answer

Firms with high levels of intangible assets tend to report higher than actual ROI on their financial statements because intangible assets are not recognized on the balance sheet and therefore do not affect the calculation of ROI.

Question 12

Which of the following is the most likely example of bias in a firm's accounting profitability measures?

Accepted Answer

The consulting firm launching a new policy to pay for MBA education for its midlevel managers (D) is the most likely example of bias in accounting profitability measures. This is because the expense of education could be capitalized and amortized over several years, rather than being expensed immediately. This accounting treatment could artificially inflate the firm's short-term profitability by deferring the expense recognition.

Question 13

Which of the following actions-all else equal-will decrease a firm's EVA?

Accepted Answer

Increasing accounts receivable ties up more capital in non-productive assets, which can increase the capital charge and decrease EVA.

Question 14

The economic rate of return on an asset is defined as

Accepted Answer

The economic rate of return is calculated by taking the present value of the cash inflows (C1) plus the present value of the salvage value (PV of S1) minus the initial investment (PV of U1B1) divided by the initial investment (PV of U1B0). Option A correctly represents this formula.

Question 15

According to the survey of senior managers by Graham, Harvey, and Rajgopal, senior managers admitted to the following:

Accepted Answer

The survey by Graham, Harvey, and Rajgopal revealed that senior managers not only adjusted operations and investments and decreased discretionary spending to meet earnings targets but also deferred or rejected positive NPV projects for the same reason.

Question 16

A factory manager can improve EVA by

Accepted Answer

The formula for EVA is Earnings – (Capital Employed x Cost of Capital). Therefore, a factory manager can improve EVA by increasing earnings and reducing capital employed. This can be achieved through efficient use of assets and reducing unnecessary investments.

Question 17

A firm has an average investment of $10,000 during the year. During the same time, the firm generates after-tax income of $2,000.
If the cost of capital is 15 percent, what is the net return on the investment?

Accepted Answer

The net return on investment is calculated as the after-tax income divided by the average investment. Here, it is $2,000 / $10,000 = 0.2 or 20%. To find the net return, subtract the cost of capital (15%) from this figure, resulting in a net return of 5%.

Question 18

Which of the following actions-all else equal-will increase a firm's EVA?

Accepted Answer

If the firm raises its prices but ships the same amount of product, it will result in a higher revenue and therefore a higher EVA, assuming all costs remain the same. The other options may have varying impacts on the firm's financials, but they do not directly impact EVA.

Question 19

A firm has an average investment of $100,000 during the year. During the same period, the firm generates an after-tax income of $16,000. If the cost of capital is 15 percent, what is the EVA?

Accepted Answer

EVA (Economic Value Added) is calculated as the net operating profit after taxes (NOPAT) minus the capital charge. The capital charge is the cost of capital times the average investment. Here, the capital charge is 15% of $100,000, which equals $15,000. The NOPAT is given as $16,000. Therefore, EVA = $16,000 - $15,000 = $1,000.

Question 20

EVA is used for

Accepted Answer

Economic Value Added (EVA) is a measure used for assessing a company's financial performance, rewarding performance through bonuses or incentives, and guiding decisions to improve performance. It calculates the value created beyond the required return of the company's shareholders, thus serving multiple purposes including measurement, reward, and improvement of performance within a firm.

Quiz 12: Agency Problems and Investment