Scorpio plc was established two years ago and has produced the following statement of financial position and income statement at the end of the second year of trading. Discussions with the finance director reveal the following:1. Marketing costs relate to the launch of a new product. The benefits

Question

Scorpio plc was established two years ago and has produced the following statement of financial position and income statement at the end of the second year of trading.

Statement of financial position as at the end of the second year
	£m
ASSETS
Non-current assets
Plant and equipment	80.0
Motor vehicles	12.4
Marketable investments	[latex]\underline{6.6} [/latex]
[latex]\underline{99.0} [/latex]
Current assets
Inventories	34.5
Receivables	29.3
Cash	[latex]\underline{2.1} [/latex]
[latex]\underline{65.9} [/latex]
Total assets	[latex]\underline{164.9} [/latex]
EQUITY AND LIABILITIES
Equity
Share capital	60.0
Retained earnings	[latex]\underline{23.7} [/latex]
[latex]\underline{83.7} [/latex]
Non-current liabilities
Loan notes	[latex]\underline{50.0} [/latex]
Current liabilities
Trade payables	30.3
Taxation	[latex]\underline{0.9} [/latex]
[latex]\underline{31.2} [/latex]
Total equity and liabilities	[latex]\underline{164.9} [/latex]

Income statement for the second year
	£m
Sales revenue	148.6
Cost of sales	[latex]\underline{(76.2)} [/latex]
Gross profit	72.4
Wages	(24.6)
Depreciation of plant and equipment	(12.8)
Marketing costs	(22.5)
Allowances for trade receivables	[latex]\underline{(4.5)} [/latex]
Operating profit	8.0
Income from investments	[latex]\underline{0.4} [/latex]
	8.4
Interest payable	[latex]\underline{(0.5)} [/latex]
Ordinary profit before taxation	7.9
Restructuring costs	[latex]\underline{(1.9)} [/latex]
Profit before taxation	6.0
Tax	[latex]\underline{(1.5)} [/latex]
Profit for the year	[latex]\underline{4.5} [/latex]

Discussions with the finance director reveal the following:

Marketing costs relate to the launch of a new product. The benefits of the marketing campaign are expected to last for three years (including this most recent year).
The allowance for trade receivables was created this year and the amount is considered to be very high. A more realistic figure for the allowance would be £2.0 million.
Restructuring costs were incurred as a result of a collapse in a particular product market. As a result of the restructuring, benefits are expected to flow for an infinite period.
The business has a 10 per cent required rate of return for investors.
The rate of tax on profits is 25 per cent.
The capital invested at the end of the year fairly reflects the average capital invested during the year.

Accepted Answer

The first step in calculating [latex]EVA^\circledR[/latex] is to adjust the net operating profit after tax to take account of the various points revealed from the discussion with the finance director. The revised figure is calculated as follows:

NOPAT adjustment
	£m	£m
Operating profit		8.0
Tax (Note 1)		[latex]\underline{(2.0)} [/latex]
6.0
EVA® adjustments (added back to profit)
Marketing costs (2/3 × 22.5)	15.0
Excess allowance	[latex]\underline{2.5} [/latex]	[latex]\underline{17.5} [/latex]
Adjusted NOPAT		[latex]\underline{23.5} [/latex]

The next step is to adjust the net assets (as represented by equity and loan notes) to take account of the points revealed.

Adjusted net assets (or capital invested)
	£m	£m
Net assets (from statement of financial position)		133.7
Marketing costs (Note 2)	15.0
Allowance for trade receivables	2.5
Restructuring costs (Note 3)	[latex]\underline{1.9} [/latex]	[latex]\underline{19.4} [/latex]
153.1
Marketable investments (Note 4)		[latex]\underline{(6.6)} [/latex]
Adjusted net assets		[latex]\underline{146.5} [/latex]

Notes:

Tax is based on 25 per cent of the operating profits and is therefore £2 million (25% × £8.0m). (Tax complications, such as the difference between the tax allowance for non-current assets and the accounting charge for depreciation, have been ignored.)
The marketing costs represent two years’ benefits added back (2/3 × £22.5m).
The restructuring costs are added back to the net assets as they provide benefits over an infinite period. (Note that they were not added back to the operating profit as these costs were deducted after arriving at operating profit in the income statement.)
The marketable investments do not form part of the operating assets of the business and the income from these investments is not part of the operating profit.

Question 11.3: Scorpio plc was established two years ago and has produced t...

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