Question

Harrison Motors Harrison Motors was opened in 2018 by five ex-employees from a larger dealership. The company specialises in high-end sports and luxury motor cars and has one of the largest inventories of used Ferraris in the Dublin area (over 20 of these cars are always in stock). The inventory is listed on the companys website and the company has delivered cars to customers as far away as Germany, although most customers are located in Ireland and the UK. In 2021, an industry publication listed Harrison as the fastest-growing motor dealership in Western Europe. Comparative income statements and balance sheets are presented below.

As indicated, the company had sales of 16,800,000 in 2021 (a 25% increase over 2020) and net income of 370,500 (a 95% increase over 2020). The owners were very pleased with the companys financial performance and satisfied that they had developed a successful business. However, at a recent meeting, the companys auditors introduced them to the concept of EVA and noted that, with an assumed weighted average cost of capital of 16%, their EVA had been negative in both 2020 and 2021. Accordingly, the owners appointed an EVA consultant to help them with financial planning.

REQUIRED:

1) Calculate EVA (and ROI) for 2020 and 2021. No adjustments for accounting distortions are needed. Explain why sales and income have increased substantially in 2021 and yet EVA is negative. What is not captured in income that is captured in EVA?

2) Assume that the average cost of a car is 50,000. The owners realise that they must cut back on inventory to earn a zero or positive EVA in the coming year. Calculate the maximum amount of inventory that could have been on hand at the end of 2021 for the company to achieve a zero level of EVA.