Reference no: EM132437309
Question - Major Gardiner (MG) is a specialty toy manufacturing company. as a new business, MG hs been growing strongly and, based on its ROE calculation, It has also been exceeding its required return on equity of 15%.
Michael Train CEO of MG, has just attended an educational seminar on shareholder value. He would now like to use economic value added (EVA) to measure whether the company has been generating shareholder value. To calculate this measure, the following information has been extracted from MG's accounting system:
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$
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Net profit after interest and tax
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22,000
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Interest expense
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5,000
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Research and development expense
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15,000
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Shareholder's equity
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105,000
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Short term debt
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29,000
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Long term debt
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110,000
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For the purpose of calculating EVA, MS Kalinda (CFO of MG) has had her finance team provide the following information:
Tax rate is 30% (assume tax expense is tax paid for EVA calculation).
Short term debt before tax interest rate is 8%.
Long term debt before tax interest rate is 7%.
In addition, Ms Kalinda believes that R&D at MG benefits the future. As such, she has stated that she believed the entire R&D budget should be treated as an asset. She has provided the following information on the economic value and use of R&D from an EVA perspective. The gross value capitalized R&D for MG is $150,000, the accumulated R&D amortization (pre-2015) and is $75,000 and the R&D amortization expense for 2015 is $43,000.
Required -
a. Based on the above information, calculate the following
i. ROE (use the Net Profit after Interest and Tax)
ii. Economic Value Added (EVA)
b. Based on your ROE calculation in part (a), what can Mr Train conclude about the performance of MG in your response, discuss three (3) disadvantages of this measure (relative to EVA).
c. Based on your EVA calculation, in part (a), do you think MG has generated shareholder value? In your answer, discuss the concept of shareholder value and provide two (2) recommendations to Mr Train for how MG could enhance its shareholder value.