Essay on The Home Depot: Analysis of Income Taxes

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According to Investopedia, EVA (Economic Value Added) is a measure of a company's financial performance based on the residual wealth calculated by deducting cost of capital from its operating profit (adjusted for taxes on a cash basis). It is calculated by using the formula NOPAT – (Total Net Operating Capital) (WACC). Calculating EVA is important because it is used as an indicator of how profitable company projects are and it serves as a reflection of management performance. There are many advantages and disadvantages of EVA. One advantage of EVA is that it summarizes how much and from where a company created wealth. It includes the balance sheet in the calculation and encourages managers to think about assets as well as expenses in their decisions. Another advantage of EVA is that it supplements financial data from other methods of business assessment and valuation. What is more, it reflects the business’s cost management and displays availability working capital after its original opportunity cost has been deducted. A third advantage of EVA is that it can be used as a managerial incentive that helps assure the continued performance of a business. It can also avoid problems associated with percentage calculations by using precise values. A disadvantage of EVA is that it can’t measure how well a capital asset manager makes use of retained earnings by way of project management and other business ventures. Capital asset managers may misuse liquid reserves instead of effectively increasing the future return on capital by reinvesting it with the aim of lowering operational costs through profitability. Another disadvantage of EVA is that it cannot valuate return on expenses, such as research and development. A third disadvantage of EVA is that it does not take into account inflation in its calculation. The following are the Home Depot and Lowes EVA calculations for 2001-2004:

EVA = NOPAT – (Total Net Operating Capital) (WACC)
EVA = EBIT (1 – Tax Rate) – (Total Net Operating Capital) (WACC)

2001 (values in millions):
Home Depot EVA = ($4,932) (1 – [$1,913/$4,957]) – ([$2,546 + $920 + $6,725] + $15,375 – [$3,436 + $717]) (12.3%) = $394,848,972.60
Lowe’s EVA = ($1,798) (1 – [$601/$1,625]) – ([$853 + $166 + $3,611] + $8,653 – [$1,715 + $221]) (11.6%) = -$183,235,384.60

2002 (values in millions):
Home Depot EVA = ($5,910) (1 – 37.6%) – ([$3,980 + $1,258 + $8,314] + $19,973 – [$5,435 + $1,142]) (12.3%) =
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