EVA/MVA The financial statements reflect historical data, but managers\' perform

Question

EVA/MVA

The financial statements reflect historical data, but managers' performance must be evaluated on the basis of -Select-bookmarketreplacementCorrect 1 of Item 1 values. To provide this information, financial analysts have developed two measures: Market Value Added (MVA) and Economic Value Added (EVA).

Market Value Added represents the difference between the money stockholders have invested in the firm versus the cash they could receive if the firm were sold. The equation for MVA is:

MVA = (Shares outstanding × Stock price) – Total common equity

Shareholder wealth is maximized when this difference is -Select-maximizedzerominimizedCorrect 2 of Item 1. The -Select-lowerhigherCorrect 3 of Item 1 a firm's MVA, the better the job management is doing for its shareholders.

Economic Value Added is sometimes called "-Select-economic profitaccounting profitnet incomeCorrect 4 of Item 1", and it is closely related to MVA. The equation for EVA is:

EVA = EBIT(1 - T) - (Total invested capital x After-tax percentage cost of capital)

Note that total invested capital is equal to the sum of notes payable, long-term debt, and total common equity. EVA differs from -Select-net worthnet incomecash flowCorrect 5 of Item 1 because EVA has a deduction for the cost of equity. Positive EVA on an annual basis helps ensure that MVA is also positive. -Select-MVAEPSEVACorrect 6 of Item 1 can be determined for divisions as well as for the firm as a whole, so it is useful for establishing reasonable compensation for divisional managers as well as top company officers.

Quantitative Problem: Rosnan Industries' 2013 and 2012 balance sheets and income statements are shown below.

Using the financial statements above, what is Rosnan's 2013 market value added (MVA)? Round your answer to the nearest dollar. Do not round intermediate calculations.

$

Using the financial statements given earlier, what is Rosnan's 2013 economic value added (EVA)? Round your answer to the nearest cent. Do not round intermediate calculations.

$

Balance Sheets: 2013 2012 Cash and equivalents $100   $85   Accounts receivable 275   200   Inventories 375   250         Total current assets $750   $635   Net plant and equipment 2,000   1,490   Total assets $2,750   $2,125   Accounts payable $150   $85   Accruals 75   50   Notes payable 150   75         Total current liabilities $375   $210   Long-term debt 450   290   Common stock 1,225   1,225   Retained earnings 700   400   Total liabilities and equity $2,750   $2,125  

Explanation / Answer

MVA = (Shares outstanding × Stock price) – Total common equity = 160*27.78-(1225+700) = $2520 (Answer) Shareholder wealth is maximized when this difference is -maximized EVA = EBIT(1 - T) - (Total invested capital x After-tax percentage cost of capital) = 650*(1-0.40) - (150+450+1225+700)*9% = $162.75 (Answer) EVA differs from net income because EVA has a deduction for the cost of equity. EVA can be determined for divisions as well as for the firm as a whole, so it is useful for establishing reasonable compensation for divisional managers as well as top company officers.

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