Business Math homework

Accounting for Financial Management: EVA/MVA

The financial statements reflect historical data, but managers' performance must be evaluated on the basis of 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 . The a firm's MVA, the better the job management is doing for its shareholders.

Economic Value Added is sometimes called "", and it is closely related to MVA. The equation for EVA is:

EVA = NOPAT - (Total net operating capital)(WACC)

EVA differs from because EVA has a deduction for the cost of equity. Positive EVA on an annual basis helps ensure that MVA is also positive. 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' 2017 and 2016 balance sheets and income statements are shown below. All of the balance of Cash and Equivalents is an operating asset.

Balance Sheets:
	2017	2016
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

Income Statements:
	2017	2016
Sales	$2,000	$1,500
Operating costs excluding depreciation	1,250	1,000
EBITDA	$750	$500
Depreciation and amortization	100	75
EBIT	$650	$425
Interest	62	45
EBT	$588	$380
Taxes (40%)	235	152
Net income	$353	$228
Dividends paid	$53	$48
Addition to retained earnings	$300	$180
Shares outstanding	180	180
Price	$20.83	$18.33
WACC	12.00%

Using the financial statements above, what is Rosnan's 2017 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 2017 economic value added (EVA)? Round your answer to the nearest cent. Do not round intermediate calculations. $

Problem 2-12 Free Cash Flows

Rhodes Corporation: Income Statements for Year Ending December 31 (Millions of Dollars)

	2016		2015
Sales	$10,000.0		$8,000.0
Operating costs excluding depreciation	8,500.0		6,800.0
Depreciation and amortization	288.0		240.0
Earnings before interest and taxes	$1,212.0		$960.0
Less Interest	215.0		172.0
Pre-tax income	$997.0		$788.0
Taxes (40%)	398.8		315.2
Net income available to common stockholders	$598.2		$472.8
Common dividends	$538.0		$378.0

Rhodes Corporation: Balance Sheets as of December 31 (Millions of Dollars)

	2016		2015
Assets
Cash	$110.0		$88.0
Short-term investments	50.0		40.0
Accounts receivable	1,352.0		1,040.0
Inventories	2,500.0		2,000.0
Total current assets	$4,012.0		$3,168.0
Net plant and equipment	2,880.0		2,400.0
Total assets	$6,892.0		$5,568.0
Liabilities and Equity
Accounts payable	$880.0		$800.0
Accruals	500.0		400.0
Notes payable	200.0		160.0
Total current liabilities	$1,580.0		$1,360.0
Long-term debt	2,000.0		1,600.0
Total liabilities	$3,580.0		$2,960.0
Common stock	3,109.8		2,466.0
Retained earnings	202.2		142.0
Total common equity	$3,312.0		$2,608.0
Total liabilities and equity	$6,892.0		$5,568.0

Using Rhodes Corporation's financial statements (shown above), answer the following questions.

a. What is the net operating profit after taxes (NOPAT) for 2016? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to one decimal place. $   million

b. What are the amounts of net operating working capital for both years? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to one decimal place. 2016 $   million 2015 $   million

c. What are the amounts of total net operating capital for both years? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to one decimal place. 2016 $   million 2015 $   million

d. What is the free cash flow for 2016? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to one decimal place. $   million

e. What is the ROIC for 2016? Round your answer to two decimal places.  %

f. How much of the FCF did Rhodes use for each of the following purposes: after-tax interest, net debt repayments, dividends, net stock repurchases, and net purchases of short-term investments? (Hint: Remember that a net use can be negative.) Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to one decimal place.

After-tax interest payment	$   million
Reduction (increase) in debt	$   million
Payment of dividends	$   million
Repurchase (Issue) stock	$   million
Purchase (Sale) of short-term investments	$   million

Basic Stock Valuation: Free Cash Flow Valuation Model

The recognition that dividends are dependent on earnings, so a reliable dividend forecast is based on an underlying forecast of the firm's future sales, costs and capital requirements, has led to an alternative stock valuation approach, known as the free cash flow valuation model. The market value of a firm is equal to the present value of its expected future free cash flows:

Free cash flows are generally forecasted for 5 to 10 years, after which it is assumed that the final forecasted free cash flow will grow at some long-run constant rate. Once the firm reaches its horizon date, when cash flows begin to grow at a constant rate, the equation to calculate the continuing value of the firm at that date is:

Discount the free cash flows back at the firm's weighted average cost of capital to arrive at the value of the firm today. Once the value of the firm is calculated, the market value of debt and preferred are subtracted to arrive at the market value of equity. The market value of equity is divided by the number of common shares outstanding to estimate the firm's intrinsic per-share value.

We present 2 examples of the free cash flow valuation model. In the first problem, we assume that the firm is a mature company so its free cash flows grow at a constant rate. In the second problem, we assume that the firm has a period of nonconstant growth.

Quantitative Problem 1: Assume today is December 31, 2016. Barrington Industries expects that its 2017 after-tax operating income [EBIT(1 – T)] will be $430 million and its 2017 depreciation expense will be $70 million. Barrington's 2017 gross capital expenditures are expected to be $100 million and the change in its net operating working capital for 2017 will be $20 million. The firm's free cash flow is expected to grow at a constant rate of 5% annually. Assume that its free cash flow occurs at the end of each year. The firm's weighted average cost of capital is 8.5%; the market value of the company's debt is $2.9 billion; and the company has 190 million shares of common stock outstanding. The firm has no preferred stock on its balance sheet and has no plans to use it for future capital budgeting projects. Using the free cash flow valuation model, what should be the company's stock price today (December 31, 2016)? Round your answer to the nearest cent. Do not round intermediate calculations. $ per share

Quantitative Problem 2: Hadley Inc. forecasts the year-end free cash flows (in millions) shown below.

Year	1	2	3	4	5
FCF	-$22.84	$37.9	$43.1	$52.3	$56.6

The weighted average cost of capital is 12%, and the FCFs are expected to continue growing at a 4% rate after Year 5. The firm has $24 million of market-value debt, but it has no preferred stock or any other outstanding claims. There are 20 million shares outstanding. What is the value of the stock price today (Year 0)? Round your answer to the nearest cent. Do not round intermediate calculations. $ per share

According to the valuation models developed in this chapter, the value that an investor assigns to a share of stock is dependent on the length of time the investor plans to hold the stock.

The statement above is .

Conclusions

Analysts use both the discounted dividend model and the free cash flow valuation model when valuing mature, dividend-paying firms; and they generally use the corporate model when valuing divisions and firms that do not pay dividends. In principle, we should find the same intrinsic value using either model, but differences are often observed.

Even if a company is paying steady dividends, much can be learned from the corporate model; so analysts today use it for all types of valuations. The process of projecting future financial statements can reveal a great deal about a company's operations and financing needs. Also, such an analysis can provide insights into actions that might be taken to increase the company's value; and for this reason, it is integral to the planning and forecasting process.

Problem 7-06 Value of Operations: Constant Growth

EMC Corporation has never paid a dividend. Its current free cash flow of $520,000 is expected to grow at a constant rate of 5.8%. The weighted average cost of capital is WACC = 14.5%. Calculate EMC's estimated value of operations. Round your answer to the nearest dollar. $

Problem 7-07 Horizon Value of Free Cash Flows

Current and projected free cash flows for Radell Global Operations are shown below.

	Actual 2016	2017	Projected 2018	2019
Free cash flow	$606.82	$667.50	$707.55	$750.00
(millions of dollars)

Growth is expected to be constant after 2018, and the weighted average cost of capital is 10.25%. What is the horizon (continuing) value at 2019 if growth from 2018 remains constant? Round your answer to the nearest dollar. Do not round intermediate calculations. $

Problem 7-17 Value of Operations

Kendra Enterprises has never paid a dividend. Free cash flow is projected to be $80,000 and $100,000 for the next 2 years, respectively; after the second year, FCF is expected to grow at a constant rate of 6%. The company's weighted average cost of capital is 17%.

a. What is the terminal, or horizon, value of operations? (Hint: Find the value of all free cash flows beyond Year 2 discounted back to Year 2.) Round your answer to the nearest cent.

$

b. Calculate the value of Kendra's operations. Round your answer to the nearest cent. Do not round intermediate calculations.

$

Problem 7-18 Free Cash Flow Valuation

Dozier Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows (FCFs) during the next 3 years, after which FCF is expected to grow at a constant 5% rate. Dozier's weighted average cost of capital is WACC = 17%.

	Year
	1	2	3
Free cash flow ($ millions)	-$20	$30	$40

a. What is Dozier's horizon value? (Hint: Find the value of all free cash flows beyond Year 3 discounted back to Year 3.) Round your answer to two decimal places. $ million

b. What is the current value of operations for Dozier? Do not round intermediate calculations. Round your answer to two decimal places. $ million

c. Suppose Dozier has $10 million in marketable securities, $100 million in debt, and 10 million shares of stock. What is the intrinsic price per share? Do not round intermediate calculations. Round your answer to the nearest cent. $