Question 11.E.6: Pisces plc produced the following statement of financial pos...
Pisces plc produced the following statement of financial position and income statement at the end of the third year of trading:
Statement of financial position as at the end of the third year
\begin{matrix}&£m\\\textbf{ASSETS}\\\textbf{Non-current assets}\\Property&40.0\\Machinery\ and\ equipment&80.0\\Motor\ vans&18.6\\Marketable\ investments&\underline{9.0}\\&\underline{147.6}\\\textbf{Current assets}\\Inventories&45.8\\Receivables&64.8\\Cash&\underline{1.0}\\&\underline{111.4}\\\textbf{Total assets}&\underline{259.0}\\\textbf{EQUITY AND LIABILITIES}\\\textbf{Equity}\\Share\ capital&80.0\\Retained\ earnings&\underline{ 36.5}\\&\underline{116.5}\\\textbf{Non-current liabilities}\\Loan notes&\underline{80.0}\\\textbf{Current liabilities}\\Trade\ payables&\underline{62.5}\\\textbf{Total equity and liabilities}&\underline{259.0}\end{matrix}Income statement for the third year
\begin{matrix}&£m\\Sales\ revenue&231.5\\Cost\ of\ sales&\underline{(143.2)}\\\textbf{Gross profit}&88.3\\Wages&(43.5)\\Depreciation\ of\ machinery\ and\ equipment&(14.8)\\&£m\\R(and)D\ costs&(40.0)\\Allowance\ for\ trade\ receivables&\underline{(10.5)}\\\textbf{Operating loss}&(20.5)\\Income\ from\ investments&\underline{0.6}\\&(19.9)\\Interest\ payable&\underline{(0.8)}\\Ordinary\ loss\ before\ taxation&(20.7)\\Restructuring\ costs&\underline{(6.0)}\\\textbf{Loss before taxation}&(26.7) \\Tax&\underline{-}\\\textbf{Loss for the year}&\underline{ (26.7)}\end{matrix}An analysis of the underlying records reveals the following:
1 R&D costs relate to the development of a new product in the previous year. These costs are written off over a two-year period (starting last year). However, this is a prudent approach and the benefits are expected to last for 16 years.
2 The allowance for trade receivables was created this year and the amount is very high. A more realistic figure for the allowance would be £4 million.
3 Restructuring costs were incurred at the beginning of the year and are expected to
provide benefits for an infinite period.
4 The business has a 7 per cent required rate of return for investors.
5 The capital employed at the end of the year fairly reflects the average capital employed during the year.
Required:
Calculate the EVA® for the business for the third year of trading.
Adjusted NOPAT
\begin{matrix}&£m&£m\\Operating\ loss&&(20.5)\\EVA^{R}\ adjustments\\R(and)D\ costs\ (40 – (1/16 \times 80))\ (Note 1)&35.0\\Excess\ allowance&\underline{ 6.5}&\underline{41.5}\\\textbf{Adjusted NOPAT}&&\underline{21.0} \end{matrix}Adjusted net assets (or capital invested)
\begin{matrix}&£m&£m\\Net\ assets\ per\ statement\ of\ financial\ position&&196.5\\Add\\R(and)D\ costs\ (Note\ 1)&70.0\\Allowance\ for\ trade\ receivables&6.5\\Restructuring\ costs\\(Note 2)&\underline{ 6.0}&\underline{82.5}\\&&279.0\\Less\ Marketable\ investments&&\underline{ (9.0)}\\\textbf{Adjusted net assets}&&\underline{270.0} \end{matrix}Notes:
1 The R&D costs represent a writing back of £40 million and a writing off of 1/16 of the total cost of the R&D as the benefits are expected to last 16 years.
2 The restructuring costs are added back to the net assets as they provide benefits over an infinite period. EVA® can be calculated as follows:
Thus, the EVA^{R} for the period is positive even though an operating loss was recorded. This means that shareholder wealth increased during the third year.