In November 2018 the Chief Examiner wrote that “more than 90% of Advanced Financial Management students could not explain bankers’ Acceptance and Commercial paper” and that candidates “could not compute the cost of capital to be used to discount the cash flows.” Question Four (Jabesh Company Ltd) tested exactly that cost-of-capital skill inside an EVA question. This article gives the full working.
The Formula
EVA = NOPAT − (k x capital), where k is WACC and capital is equity plus long-term debt at the start of the period.
Step 1: NOPAT (GH¢’000)
Operating profit 6,500; add Project Z R&D 500; less Project X amortisation (750); add doubtful-debt allowance movement 100; add non-cash expenses 15; less cash taxes (1,625) = 4,740 for 2017. For 2016: 5,500 + 500 − 750 − 50 + 15 − 1,375 = 3,840. Cash taxes = tax charge plus the tax relief on interest (1,375 + 250 = 1,625; 1,150 + 225 = 1,375).
Step 2: Adjusted Capital Employed at 1 January
2017: 37,000 + 250 + 500 + 750 + 15 = 38,515. 2016: 33,500 + 300 + 1,500 = 35,300.
Step 3: WACC
2017: 0.6 x 14% + 0.4 x 5% x (1 − 0.25) = 8.4% + 1.5% = 9.9%. 2016: 7.2% + 1.5% = 8.7%.
Step 4: EVA
2017: 4,740 − 9.9% x 38,515 = GH¢927,000 (approx.). 2016: 3,840 − 8.7% x 35,300 = GH¢769,000 (approx.).
Spin-off vs Sell-off
A spin-off creates an independent company by distributing new shares of a division to the parent’s shareholders. Reasons: better management, separating growth strategies, better analyst coverage, unlocking shareholder value. A sell-off sells a division to a third party for cash.
What the Examiner Said About the Question
“The majority of the students lacked understanding of what EVA is all about.” And: “This is a question that combines so many topics in the syllabus… Most of the students could not apply all the principles involved.” And: spin-off vs sell-off “was fairly answered by the students who had read the topic.”
EXAM TIP: Label four steps: NOPAT, adjusted capital, WACC, EVA. Cost of capital appears in “almost all the questions” per the examiner, so treat it as core, not optional.
Conclusion
The examiner’s message is not to learn more topics. It is to stop skipping the foundations that sit inside every topic.
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