What is EP during Year 1?

A. –12,101.

B. –6,000.

C. 6,000.

Mun Hoe Yip is valuing Pure Corporation. Pure is a simple corporation that is going out of business in five years, distributing its income to creditors and bondholders as planned in the financial statements below. Pure has a 19 percent cost of equity, 81/3 percent before-tax cost of debt, 12 percent weighted average cost of capital, and 40 percent tax rate, and it maintains a 50 percent debt/value ratio.
Yip is valuing the company using the basic capital budgeting method as well as other methods, such as EP, residual income, and claims valuation. Yip’s research assistant, Linda Robinson, makes three observations about the analysis.
Observation 1: “The present value of the company’s economic income should be equal to the present value of the cash flows in the basic capital budgeting approach.”
Observation 2: “The economic income each year is equal to the cash flow minus the economic depreciation.”
Observation 3: “The market value added is the present value of the company’s economic profit (EP), which equals the net worth of 77,973.”

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Year 0 1 2 3. 4 Balance Sheets: Assets 200,000 160,000 120,000 80,000 40,000 Liabilities 122,027 107,671 88,591 64,222 33,929 0 Net worth 77973 52,329 31,409 15.778 6,071 0 Income Statements: Sales 180,000 200,000 220,000 240,000 200,000 Variable cash expenses 90,000 100,000 110,000 120,000 100,000 Fixed cash expenses 20,000 20,000 20,000 20,000 20,000 Depreciation 40,000 40,000 40,000 40,000 40,000 EBIT 30,000 40,000 50,000 60,000 40,000 Interest expense 10,169 8,973 7.383 5.352 2,827 EBT 19,831 31,027 42,617 54,648 37,173 Taxes at 40 percent 7,932 12,411 17,047 21,859 14,869 Net income before salvage 11,899 18,616 25.570 32,789 22,304 After-tax salvage value 12,000 Net income 11,899 18,616 25.570 32,789 34,304 Statements of Cash Flows: Operating cash flows: Net income 11,899 18,616 25.570 32,789 34,304 Depreciation 40,000 40,000 40,000 40,000 40,000 Total 51,899 58,616 65,570 72,789 74,304 Financing cash flows: Debt repayment 14,357 19,080 24,369 30,293 33.929 Dividends/repurchases 37,542 39,536 41,201 42,496 40,375 Total -51,899 -58,616 -65.570 -72,789 -74,304 Investing cash flows: 0 0 0 0 0 Total cash flows: 0 0 0 0