a. Calculate EVA for 2020 and 2019, using a cost of capital of 12 percent. No adjustments for accounting distortions are needed. Explain why sales and income have increased substantially in 2020 and yet EVA is negative. What is not captured in income that is captured in EVA? 

b. The owners realize they must cut back on inventory to earn a zero or positive EVA in the coming year. To get a handle on this, they would like you to calculate the maximum amount of inventory that could have been on hand at the end of 2020 for the company to achieve a zero level of EVA. 

c. Assume the average car has a cost of $75,000. Also assume that sales, expenses, assets (except inventory), and liabilities are roughly the same in 2021 as in 2020. How many cars must be cut from inventory to achieve zero EVA in 2021? 

In 2019, five retired software developers opened an auto dealership in Redmond, Washington, which they named WinTechMotors. The company specializes in high-end sports and luxury autos and has one of the largest inventories of used Porsches on the West Coast. (Typically, 75 Porsches are in stock). The inventory is listed on the company’s website and the company has shipped cars to online customers as far away as Florida, although most customers are located in Washington, Oregon, and California. In 2020, an industry publication (Motor Watch) listed WinTech as the fastest-growing luxury auto dealership on the West Coast. Comparative income statements and balance sheets are presented in the table on the right. As indicated, the company had sales of $15,120,000 in 2020 (a 25 percent increase over 2019) and net income of $402,400 (a 91 percent increase over 2019). The owners were delighted with the company’s financial performance and quite proud that they had developed a successful business. However, at a recent meeting, their company’s external accountants introduced them to the concept of EVA and noted that, with an assumed weighted average cost of capital of 12 percent, their EVA had been negative in both years. Accordingly, the owners have contracted with an EVA consultant to help them with financial planning.

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Comparative Financial Statements: WinTech Motors 2020 2019 Sales $15,120,000 $12,105,000 Less cost of autos sold 13,618,000 10,894,000 Gross margin Less selling and administrative expense 1,502,000 1,211,000 936,000 889,200 Interest 63,000 58,500 Income before taxes 503,000 263,300 Income taxes 100,600 52,660 Net income $ 402,400 $ 210,640 Increase in sales 24.91% Increase in net income 91% Assets Cash and short-term investments 2$ 58,500 63,000 Receivables 355,500 288,000 Inventory 5,625,000 5,040,000 Current assets 6,039,000 5,391,000 Building and equipment (net) 860,400 855,000 Other assets 48,600 54,000 Total assets $ 6,948,000 $ 6,300,000 Liabilities and Shareholders' Equity Accounts payable Short-term debt payable Taxes payable $ 276,300 $ 117,000 81,000 67,500 103,500 36,000 Current liabilities 460,800 220,500 Long-term debt payable 625,500 544,500 Total liabilities 1,086,300 765,000 Retained earnings 821,700 495,000 Common stock 5,040,000 5,040,000 Total liabilities and shareholders' equity $ 6,948,000 $ 6,300,000