a) K&M Co
Subject:FinancePrice:2.86 Bought10
a) K&M Co. is considering an investment. The project is expected to be financed by $2,000,000 of bank loans and $3,000,000 of common equity. It is known that the firm’s weighted average cost of capital (WACC) is 9.8% and the investment is expected to generate a net operating profit after tax (NOPAT) of $480,000. The company’s tax rate is 30%.
(i) What is the project’s Economic Value Added (EVA)?
(ii) Should the firm accept or reject the investment? Explain your reason(s).
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i)
Economic Value Added (EVA) = NOPAT - (total investment * WACC)
Economic Value Added (EVA) = 480000 - ((2000000+3000000) * 9.8%) = 480000 - 490000 = -1000
ii)
Firm should reject the investment as its EVA is negative, which means firm is not generating value from the funds invested.
