Your firm, Something Comfortable Inc. (SCC) has $2 billion of capital invested in several telecommunication projects, which are expected to generate a pre-tax operating profit of $180 million next year. SCC has an estimated pre-tax cost of capital of 20 percent.


a. What is the pre-tax economic value added (EVA) that SCC is expected to generate next year? Calculate EVA first based on pre-tax operating profit and then based on expected return on invested capital.





b. SCI is considering five possible actions, which should improve its expected pre-tax EVA. These are as follows:

1. A $10 million reduction in operating expenses that should not affect revenue.
2. A $60 million reduction in invested capital that should not affect operating profit.
3. A re-examination of its capital structure (debt-to-equity ratio) that could lower its pre-tax cost of capital to 14 percent.
4. The sale of assets at their book value of $100 million. These assets are expected to generate a pre-tax operating profit of $10 million next year.
5. The acquisition of assets of $100 million. These assets are expected to generate a pre-tax operating profit of $10 million next year.