Applying the EVA® Performance Measure to a Start-Up Company Two good friends, Mike Morley and John Baird, got together after graduating with MBA degrees in international business and decided to form an import business out of Thailand and Vietnam. Both had spent significant time in Southeast Asia during college working in the school’s study abroad program. They recognized an opportunity to import sports clothing and shoes out of these two countries into the United States for sale to college students.

They worked hard to identify good production facilities in Thailand and Vietnam that they felt employed workers fairly and safely. They felt that this was a critical selling point to college students who are typically sensitive to issues of worker exploitation. After securing distribution partners in 20 key universities across the United States, Mike and John felt ready to begin the business. They had secured a $250,000 loan to match the $250,000 investment made by a venture capitalist firm that targeted start-up business by recent MBA graduates.

Having studied finance in their MBA program, Mike and John were able to effectively compute the weighted average cost of capital on their $500,000 fund to be 14.5%. They were also fortunate to be able to maintain $50,000 in inventory on account from their Thailand and Vietnam suppliers. Hence, Mike and John’s first year of business was conducted with a total asset base of $550,000. At the end of the year, their net operating profit before interest and taxes was $88,000. John and Mike were pleased with the results of their first year of business, but they knew that the business needed to do better if it was to succeed.

Required:

1. Compute the Economic Value Added for Mike and John’s first year of operations (assume an effective income tax rate of 35%).

2. Explain why the EVA® is different from operating profit for Mike and John’s business.