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ACCA Strategic Professional · Advanced Performance Management · Financial performance measurement

Elmora plc has operating profit after tax (NOPAT) of $48m, capital employed of $400m and a weighted average cost of capital of 10%. Management is considering a project that would add $50m of capital and earn NOPAT of $6.5m a year. Using economic value added (EVA) as the sole criterion, what is the effect of the project on the company's annual EVA, and what is the current EVA?

Current EVA is $8m, being NOPAT of $48m less a capital charge of $40m. The project earns $6.5m against a charge of $5m, adding $1.5m of EVA, so it increases shareholder value and should be accepted on this criterion.

  1. ACurrent EVA $8m; the project adds $1.5m, so it should be acceptedCorrect
  2. BCurrent EVA $8m; the project reduces EVA by $1.5m, so it should be rejected
  3. CCurrent EVA $48m; the project adds $6.5m, so it should be accepted
  4. DCurrent EVA $4.8m; the project adds $1.5m, so it should be accepted

Explanation

Current EVA = 48 - (10% x 400) = 48 - 40 = $8m. Project EVA = 6.5 - (10% x 50) = 6.5 - 5 = +$1.5m, so it increases EVA and should be accepted. Ignoring the capital charge (option C) overstates the value created.

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