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By finding NOPAT, the interest expense added back is the after-tax interest, i.e. 70% * $8= $5.6 in 2014, then why aren’t the other expenses (already included) in PAT like the non-cash expenses and R&D not added back at 70% of their amounts, since they have also been taxed?
With regard to interest, you want to get to NOPAT ie the profit after tax as though no interest had been paid. You are not really adjusting for tax, you are primarily adjusting to get the pre-interest after tax figure ie NOPAT.
So, if operating profits were 100, interest was 20 and tax was 30%, the accounting PAT figure would be:
(100 – 20) x 70% = 56
The NOPAT would be either 100 x 70% = 70 or, working back would be 56 + 20 x 70% = 70.
Looking at R&D. Say profits before R&D were 150 and R&D was 40, then if tax is 30%, the tax bill would be (150 – 40) x 30% = 33. Whatever R&D adjustment we do to calculate EVA, the tax figure will still be 33 as that is the amount paid, so the NOPAT here would be: 150 – 33 = 117.
Not sure if I’m right but I will give it a try.
Interest is an expense and therefore a P&L item so it is subjected to the NOPAT definition. If it is added back to profit, then the amount is subjected to tax and therefore only the net-of-tax amount is added back.
R&D, marketing, provision and non-cash items are added back not as expense items as these costs should not be deducted in the first place and should be capitalized just like an amount spent to buy fixed assets rather than being an expense. The amount capitalized is therefore not subjected to tax and no further adjustment to tax is needed for these items capitalized.
What you need for NOPAT is the tax which would be paid before interest.
Take R&D. This is a legitimate expense for tax and the tax calculation will take this into account. Whether for EVA you write off R&D or capitalise it there will be no effect on the tax paid as that is worked out using tax legislation.
To go from PAT to NOPAT you are effectively trying to get figures that would apply had no interest been paid. The interest costs are taken account of in the WACC calculation and applying WACC to the opening capital employed. If there is no interest then there is no tax relief on interest so only the net interest is adjusted for. The tax relief on interest is effectively take account of in the WACC calculation.
Don’t spend too long on this?
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