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Split: EVA

Forums › Ask CIMA Tutor Forums › Ask CIMA P2 Tutor Forums › Split: EVA

  • This topic has 1 reply, 1 voice, and was last updated 1 year ago by Cath.
Viewing 2 posts - 1 through 2 (of 2 total)
  • Author
    Posts
  • November 17, 2021 at 1:35 pm #640883
    kirstyq
    Participant
    • Topics: 1
    • Replies: 0
    • ☆

    Hi,

    When adding back the net interest costs to NOPAT, why do we not also adjust the retained earnings bf, like we do for non-cash expenses or R&D? I’m specifically looking at chapter 5, example 5 of the P2 lecture notes.

    Thanks!

    December 29, 2021 at 10:13 pm #645030
    Cath
    Member
    • Topics: 0
    • Replies: 423
    • ☆☆☆

    Hi Kirsty,
    Great question & sorry for the delay.

    One key consideration for this item is the adjustment of the cost of interest. The cost of interest is included in the finance charge (WACC*capital) that is deducted from NOPAT in the EVA calculation and
    can be approached in two ways:

    Starting with operating profit, then deducting the adjusted tax charge (because tax charge includes the tax benefit of interest). Therefore,
    we should multiply the interest by the tax rate and add this to the tax charge; or start with profit after tax and adding back the net cost of interest.
    Therefore, we should multiply the interest charge by (1-tax rate).

    The reason we do this is that we are using WACC so otherwise we would essentially be deducting interest cost twice

    So the accounting adjustments are to remove the distortions that accountants make to the figures.
    expenditures on R&D, promotion, and employee training should be capitalised.

    Depreciation charge is added back to profit and instead, a charge for economic depreciation is made. This reflects the true change in the
    value of assets during the period, unlike accounting depreciation.

    Accounts such as provisions, allowances for doubtful debts, deferred tax provisions, and allowances for inventory should be added back to
    capital implied.

    Non-cash expenses should be added back to profits and to capital employed.

    Operating leases should be capitalised and added back to capital employed.

    Tax charge will be based on cash taxes, rather than the accruals-based methods used in financial reporting.

    So its a cash based profit based calculation based on opening balances.

    We want to know, what was the shareholder value before all the accounting
    distortions?
    Therefore, we would NOT adjust retained earnings brought forward because we are trying to establish the ‘value added’ for the shareholder.

    Hope that explains ok
    Cath

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