| Sales revenue | $150,000 |
| Less: Cost of goods sold | 30,000 |
| Gross margin | $120,000 |
| Operating expenses | |
| Rent | 5,000 |
| Wages | 50,000 |
| Supplies | 5,000 |
| Total operating expenses | 60,000 |
| Operating income | 60,000 |
| Interest expense | (20,000) |
| Net income | $40,000 |
| Assets | |
| Cash | $25,000 |
| Inventory | 25,000 |
| Current assets | $50,000 |
| Fixed assets (net) | 270,000 |
| Total assets | $320,000 |
| Liabilities | |
| Accounts payable | $20,000 |
| Loan payable | 200,000 |
| Owner’s equity | |
| S. Nelson, capital | 100,000 |
| Total liabilities and owner’s equity | $320,000 |
This table estimates the capital charge for this new, more highly leveraged firm. Once again, check out the components of the capital charge. The trade vendors, who supply $20,000 of trade credit in the form of accounts payable, don’t charge anything, so there’s no capital charge for their contribution to the firm’s capital structure. In the new, more highly leveraged firm, the bank loan charge has gone way up. Now the firm is carrying a $200,000 loan. With 10 percent interest, the capital charge on the loan rises to $20,000 annually.
| Trade vendors ($20,000 @ 0 percent) | $0 |
| Bank loan ($200,000 @ 10 percent) | 20,000 |
| Owner’s equity ($100,000 @ 20 percent) | 20,000 |
| Adjusted capital charge | $40,000 |
When you add up all the bits and pieces, you come up with an adjusted capital charge of $40,000. Remember that this is the capital charge for the new, more highly leveraged business.
For this new, more highly leveraged business, the EVA changes. The adjusted income for the business is $60,000 (calculated as the $40,000 of net income plus $20,000 of interest expense). You can calculate the EVA by subtracting the $40,000 capital charge from the $60,000 of adjusted income. The result equals $20,000 of EVA. The EVA doubles, obviously, when the business is more highly leveraged.
This example shows why the more complicated EVA formula can be useful. The example recognizes more explicitly how EVA results when a firm produces income in excess of the capital charges.