A large consulting firm is looking to expand the services currently offered its clients. The firm has
Question:
Client’s Traditional Income Statement
Revenues ............. $ 5,700
Cost of goods sold......... (2,000)
Gross margin............ $ 3,700
Depreciation............ (900)
Selling, general, other.......... (700)
Interest ............ .. (500)
Earnings before taxes........ $ 1,600
Income taxes (40%)......... (640)
Net income ............ $ 960
Suppose the client has total assets of $ 6,000 and a risk- adjusted weighted- average cost of capital (WACC) of 25 percent. Then this client’s EE is calculated as follows:
Client’s Economic Earnings
Net income............ $ 960
Depreciation............ 900
Capital charge*.......... (1,500)
Economic earnings........ $ 360 *
Total assets $ 6,000 WACC...... 25%
Capital charge .......... $ 1,500
Required:
Critically evaluate EE as a performance measure. What are its strengths and weaknesses?
Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of...
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Related Book For
Accounting for Decision Making and Control
ISBN: 978-0078025747
8th edition
Authors: Jerold Zimmerman
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