# P5: common pitfalls - and how to avoid them

### Solutions to technical extracts

#### 1. Basic contribution analysis

Total variable costs per unit (marginal costs) = 90 + 60 + 40 + 45 + 20 = \$255

Selling price per unit = \$448m/1.12m = 400

Contribution/unit = 400 – 255 = \$145

Total fixed costs = 18 + 16 + 6 + 80 = \$120m

Break-even point = Fixed costs/contribution per unit = \$120m/145 = 0.8276m units

Current sales = 1.12m

Margin of safety % = 100 x (1.12 – 0.8276)/1.12 = 26.1%

#### 2. WACC calculation

Debt/Equity = 30% so \$30m for debt and \$100m for equity. Total capital is therefore \$130m

WACC uses the post-tax cost of debt, but the data provided is for the pre-tax cost of debt.

WACC = ((15.7 x (100/130)) +(( 6.5 x (1 – 0.25) x (30/130)) = 13.2%

#### 3. ROCE and EVA™

For ROCE, either opening or closing capital can be used

Using opening capital:

ROCE = Profit before interest and tax /long term capital employed

=  2,907/(8,984 + 9,801) = 15.5%

Using closing capital:

=  2,907/(9,961 + 9,739) = 14.8%

EVA™ = NOPAT – Capital employed x WACC

\$m

Net income after tax
and interest

1,953

291

Less:
tax relief on interest 0.28 x 291

(81)

NOPAT

2,163

or

\$m

Operating profit

2,907

Less: tax

(663)

Less: tax benefit of interest

(81)

NOPAT

2,163

EVA = 2,163 – ((0.11 x (8,984 + 9,801)) = 97

Note: EVA™, by definition, must be calculated using opening capital.