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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

Zentra Foods, a listed manufacturer, has a share price that has risen steadily while its earnings per share have stagnated. The board wants a measure of whether management is creating wealth for shareholders after charging for the cost of all capital used. Which measure best meets this need?

Economic value added is best because it deducts a charge for all capital employed at the weighted average cost of capital from post-tax operating profit. A positive figure shows that wealth is created for shareholders, whereas EPS, margins and dividend cover ignore the cost of capital.

  1. AEconomic value added (EVA), based on operating profit after tax less a charge for capital employedCorrect
  2. BEarnings per share growth
  3. CGross profit margin
  4. DDividend cover

Explanation

EVA deducts a charge for the capital used (capital employed multiplied by WACC) from post-tax operating profit, so it shows whether value is created above the required return. EPS growth and margins ignore the cost of capital, and dividend cover only shows the safety of dividends.

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