Question 11.SE.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 | |
| £m | |
| ASSETS | |
| Non-current assets | |
| Property | 40.0 |
| Machinery and equipment | 80.0 |
| Motor vans | 18.6 |
| Marketable investments | |
| Current assets | |
| Inventories | 45.8 |
| Receivables | 64.6 |
| Cash | |
| Total assets | |
| EQUITY AND LIABILITIES | |
| Equity | |
| Share capital | 80.0 |
| Retained earnings | |
| Non-current liabilities | |
| Loan notes | |
| Current liabilities | |
| Trade payables | |
| Total equity and liabilities | |
| Income statement for the third year | |
| £m | |
| Sales revenue | 231.5 |
| Cost of sales | |
| Gross profit | 88.3 |
| Wages | (43.5) |
| Depreciation of machinery and equipment | (14.8) |
| R&D costs | (40.0) |
| Allowance for trade receivables | |
| Operating loss | (20.5) |
| Income from investments | |
| (19.9) | |
| Interest payable | |
| Ordinary loss before taxation | (20.7) |
| Restructuring costs | |
| Loss before taxation | (26.7) |
| Tax | |
| Loss for the year | |
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.
Required:
Calculate the EVA for the business for the third year of trading.
Pisces plc
| Adjusted NOPAT | ||
| £m | £m | |
| Operating loss | (20.5) | |
| EVA adjustments | ||
| R&D costs (40 − (1/16 × 80)) (Note 1) | 35.0 | |
| Excess allowance | ||
| Adjusted NOPAT | ||
| Adjusted net assets (or capital invested) | ||
| £m | £m | |
| Net assets per statement of financial position | 196.5 | |
| Add | ||
| R&D costs (Note 1) | 70.0 | |
| Allowance for trade receivables | 6.5 | |
| Restructuring costs (Note 2) | ||
| 279.0 | ||
| Less Marketable investments | ||
| Adjusted net assets | ||
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:
EVA = NOPAT − (R × C)
= £21m − (7% × £270m)
= £2.1m
Thus, the EVA for the period is positive even though an operating loss was recorded.
This means that shareholder wealth increased during the third year.