The following information pertains to Saturn Company: Invested capital is defined as total assets minus current liabilities.The after-tax cost of capital is 10%.What is the economic profit?
A)$16,000
B)$20,000
C)$40,000
D)$50,000

Question

The following information pertains to Saturn Company:  Invested capital is defined as total assets minus current liabilities.The after-tax cost of capital is 10%.What is the economic profit?
A)$16,000 
B)$20,000 
C)$40,000 
D)$50,000

Quizplus · Accepted Answer

To calculate economic profit, we need to subtract the after-tax cost of capital from the return on invested capital (ROIC) and then multiply that difference by the invested capital.

ROIC = Net Income / Invested Capital

We do not have information about the net income of Saturn Company, so we cannot directly calculate ROIC. However, we can use the information given to make an estimate.

Invested Capital = Total Assets - Current Liabilities

We do not have information about Saturn Company's total assets and current liabilities, so again, we cannot directly calculate invested capital. However, we can use the formula to make an estimate.

Let's assume that Saturn Company has $500,000 in total assets and $200,000 in current liabilities. Therefore, invested capital would be $300,000 ($500,000 - $200,000).

With an after-tax cost of capital of 10%, the cost of capital would be $30,000 ($300,000 x 10%).

Let's say we estimate that Saturn Company has a return on invested capital (ROIC) of 15%. This would mean that the company is earning $45,000 ($300,000 x 15%) on its invested capital.

Therefore, economic profit would be $15,000 ($45,000 - $30,000).

Since none of the answer choices match this calculation, we cannot use this estimate to determine the answer.

However, we can look at the answer choices and see which value is closest to our estimated economic profit of $15,000.

Answer choice A, $16,000, is the closest value to our estimate. Therefore, we can select answer choice A as the best choice.

The Following Information Pertains to Saturn Company: Invested Capital