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ACCA Strategic Professional · Advanced Financial Management · The role and responsibility of senior financial executive/advisor

Kestrel Ltd has an opening capital employed of $200m, a cost of capital of 9% and an operating profit after tax (NOPAT) of $26m. It is considering a project needing a $20m investment with a NOPAT of $1.6m a year. Economic value added (EVA) is measured as NOPAT less a capital charge on opening capital. What is Kestrel's EVA before the project, and what is the effect on the company's EVA of accepting the project?

Current EVA is $26m minus a capital charge of $18m, which is $8m. The project earns $1.6m against a charge of $1.8m, so it reduces EVA by $0.2m. Accepting it would therefore reduce EVA even though profit rises.

  1. AEVA of $8m; project adds $(0.2)mCorrect
  2. BEVA of $8m; project adds $1.6m
  3. CEVA of $17m; project adds $(0.2)m
  4. DEVA of $8m; project adds $0.2m

Explanation

Current EVA = 26 - (9% x 200 = 18) = $8m. The project's EVA = 1.6 - (9% x 20 = 1.8) = -$0.2m, so it reduces EVA, although it increases NOPAT. The $1.6m option ignores the capital charge.

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