Calculating EVA

Brewster Company manufactures elderberry wine. Last year, Brewster earned operating income of $$186,000$ after income taxes. Capital employed equaled $$2\mathrm{.}3$ million. Brewster is $40$ percent equity and $60$ percent $10-$year bonds paying $6$ percent interest. Brewster's marginal tax rate is $40$ percent. The company is considered a fairly risky investment and probably commands a $12-$point premium above the $5$ percent rate on long$-$term Treasury bonds.

Jonathan Brewster's aunts, Abby and Martha, have just retired, and Brewster is the new CEO of Brewster Company. He would like to improve EVA for the company. Compute EVA under each of the following independent scenarios that Brewster is considering.

$1.$ No changes are made; calculate EVA using the original data.

$2.$ Sugar will be used to replace another natural ingredient $($atomic number $33)$ in the elderberry wine. This should not affect costs but will begin to affect the market assessment of Brewster Company, bringing the premium above long$-$term Treasury bills to $10$ percent the first year and $7$ percent the second year. Calculate revised EVA for both years.

$3.$ Brewster is considering expanding but needs additional capital. The company could borrow money, but it is considering selling more common stock, which would increase equity to $80$ percent of total financing. Total capital employed would be $$3,400,000.$ The new after$-$tax operating income would be $$395,000.$ Using the original data, calculate EVA. Then, recalculate EVA assuming the materials substitution described in Requirement $2.$ New after$-$tax income will be $$395,000,$ and in Year $1,$ the premium will be $10$ percent above the long$-$term Treasury rate. In Year $2,$ it will be $7$ percent above the long$-$term Treasury rate. $($Hint: You will calculate three EVAs for this requirement.$)$

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