The economic value added is also called the EVA. In this financial measurement we are interested in finding if a projects NOPAT is sufficient to cover the cost of maintaining the assets that it uses. In other words, if a project uses a share of the company's assets, those assets have certain expenses associated with them. These expenses are the cost of interest on borrowed funds and the compensation paid to shareholders in the company. The rationale here is that the only way a company can acquire assets is by borrowing the money to purchase them, having investors purchase stock in the company, or generating profits. Organizations that lend money to companies are compensated in the form on interest payments. Stockholders are compensated in the form of dividends on their share of the company. The revenue generated by the project must be enough to meet all of the project's costs and expenses as well as offset the interest expense and dividends to the stockholders.
The first thing we will have to calculate is the cost of capital. This is the weighted average cost of the money paid to the stockholders in the form of dividends and the money paid to the lenders in the form of interest payments.
Suppose a company's assets are financed by 70 percent in stock sold to investors and 30 percent in funds borrowed from banks and other financial institutions in the form of loans. The average interest that is paid on the loans is 7 percent, and the company dividends are 17 percent. What is the cost of capital for this company?
Seventy dollars out of every $100 of the company's assets are financed by stockholders at 17 percent, or $11.90 per year. Thirty dollars of every $100 of the company's assets are financed by lenders at 7 percent, or $2.10 per year. The total cost of capital per $100 is $14, or 14 percent of the company's assets.
If we take the capital or the assets that are used for this project and multiply by the cost of capital, we will get the weighted average cost of capital (WACC).
The first thing we will have to calculate is the cost of capital. This is the weighted average cost of the money paid to the stockholders in the form of dividends and the money paid to the lenders in the form of interest payments.
Suppose a company's assets are financed by 70 percent in stock sold to investors and 30 percent in funds borrowed from banks and other financial institutions in the form of loans. The average interest that is paid on the loans is 7 percent, and the company dividends are 17 percent. What is the cost of capital for this company?
Seventy dollars out of every $100 of the company's assets are financed by stockholders at 17 percent, or $11.90 per year. Thirty dollars of every $100 of the company's assets are financed by lenders at 7 percent, or $2.10 per year. The total cost of capital per $100 is $14, or 14 percent of the company's assets.
If we take the capital or the assets that are used for this project and multiply by the cost of capital, we will get the weighted average cost of capital (WACC).