Smith Industries is in desperate need of a new press machine for their production department. The manager has been asked to select the most favorable option while keeping in mind that any decision made may also impact their department's evaluation. Given this, the manager knows that performing a thorough analysis is crucial. A machine could be purchased from Grove Inc. for a total cost of $9,677 and would generate Operating Income of $3,705. A different machine could be purchased from Forest Inc. for a total cost of $9,003 and would generate Operating Income of $3,432. The company has provided the following information: What is the percentage difference in EVA for the press machine from Grove when compared to the press machine from Forest? (Do not round intermediate calculations.)
A) The EVA of the press machine from Forest is 7.49% higher than the EVA of the press machine from Grove.
B) The EVA of the press machine from Forest is 8.1% higher than the EVA of the press machine from Grove.
C) The EVA of the press machine from Grove is 7.49% higher than the EVA of the press machine from Forest.
D) The EVA of the press machine from Grove is 8.1% higher than the EVA of the press machine from Forest.

Question

Smith Industries is in desperate need of a new press machine for their production department. The manager has been asked to select the most favorable option while keeping in mind that any decision made may also impact their department's evaluation. Given this, the manager knows that performing a thorough analysis is crucial. A machine could be purchased from Grove Inc. for a total cost of $9,677 and would generate Operating Income of $3,705. A different machine could be purchased from Forest Inc. for a total cost of $9,003 and would generate Operating Income of $3,432. The company has provided the following information:  What is the percentage difference in EVA for the press machine from Grove when compared to the press machine from Forest? (Do not round intermediate calculations.)
A) The EVA of the press machine from Forest is 7.49% higher than the EVA of the press machine from Grove. 
B) The EVA of the press machine from Forest is 8.1% higher than the EVA of the press machine from Grove. 
C) The EVA of the press machine from Grove is 7.49% higher than the EVA of the press machine from Forest. 
D) The EVA of the press machine from Grove is 8.1% higher than the EVA of the press machine from Forest.

Quizplus · Accepted Answer

In order to solve for the tax rate, the formula for EVA will eventually be used, but first, solve for the Weighted Average Cost of Capital (WACC). WACC = (Cost of Debt × Proportion of Capital Financed with Debt) + (Cost of Equity × Proportion of Capital Financed with Equity). WACC = (0.065 × 0.65) + (0.083 × 0.35) = 0.04225 + 0.02905 = 0.0713. Now, the EVA formula can be used to calculate the tax rate. EVA = After-Tax Operating Income - (WACC × Investment). 
Grove Press Machine: EVA = ($3,705 × (1 - 0.22)) - (0.0713 × $9,677). EVA = $2,889.90 - $689.97. EVA = $2,199.93.
Forest Press Machine: EVA = ($3,432 × (1 - 0.22)) - (0.0713 × $9,003). EVA = $2,676.96 - $641.91. EVA = $2,035.05.
To calculate the percentage difference, use horizontal analysis. (Grove Machine EVA - Forest Machine EVA)/(Forest Machine EVA) = ($2,199.93 - $2,035.05)/$2,035.05 = $164.88/$2,035.05 = 0.0810. The Grove Press Machine has an EVA that is 8.1% higher than the Forest Press Machine (Choice D).

Smith Industries Is in Desperate Need of a New Press