FINE 2000 Lecture Notes - Lecture 4: Nopat, Asset, Profit Margin

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10 Jan 2017

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Market capitalization total market value of equity. Market capitalization = share price * # of shares outstanding. Market value added (mva) market capitalization minus book value of equity. Mva = market capitalization bv of equity. Economic value added and accounting rates of return. Economic value added (eva or residual income) measures the net profit of a firm after deducting the cost of capital. Eva or residual income is a better measure of company performance than accounting profits. Eva recognizes that companies need to cover their cost of capital before they can add value. The firm only creates value if it can earn more than its cost of capital. *recall the cost of capital is the minimum rate of return that investors expect (it equals the return that investors can get for another investment with the same level of risk) Residual income (eva) = after-tax operating profit (cost of capital * total capital)

Related Questions

What is the market price of a share of stock for a firm that pays dividends of $1.20 per share, has a P/E of 14, and a dividend payout ratio of 0.4?

The Market Value Added (MVA) is the ____.

indicator of how successful a firm has been at increasing its financing its assets
return on total capital minus cost of capital
indication of an increase in operating efficiency
positively related to the present value of all expected future EVA.

For our purpose, Shareholders' Value Maximization will be the preferred goal for all of the following reasons EXCEPT:

The shareholders' value maximization goal deals with accounting profit, while the profit maximization goal attempts to make cash available to meet financial needs.
Shareholders' value maximization is a long-run goal and the public image of the corporation may be of deep concern to shareholders including the wealth effect
The effects of all financial decisions are reflected in the price of the stock being traded in efficient markets
The complexities and uncertainties in the external environment are all absorbed in the value of the stock.

salmoncicada724

_____________ is the difference between the market value of the firm (i.e., the sum of the market value of common equity, the market value of debt, and the market value of preferred stock) and the book value of the firmâs common equity, debt, and preferred stock. ______________ represents the residual income that remains after the cost of all capital, including equity capital, has been deducted.

_______________ is the profit from the sale of a capital asset for more (less) than its purchase price. ____________ can be carried backward for 2 years or forward for 20 years to offset taxable income in a given year.

__________________ is the amount of interest bearing debt, preferred stock, and common equity used to acquire the companyâs net operating assets. Without this capital a firm cannot exist, as there is no source of funds with which to finance operations.

_______________ is the amount of net income a company would generate if it had no debt and held no financial assets. So it is a better measure of the performance of a companyâs operations because debt lowers income.

19. _____________ and ________ ___ are two important types of derivatives, and their values depend on the prices of other assets.

20. The four most fundamental factors affecting the cost of money are ___________________, _______________ for consumption, _____________, and _______________.

21. Corporations that own less than 20% of the stock of the dividend paying company can exclude 70% of the dividends received; firm that own more than ____________% but less than ___________% can exclude _________% of the dividends; and firms that own more than _____________% can exclude the entire dividend payment.

AQ-8

Blue Transport Company

Blue Transport Company operates a Truck Rental Division (that rents trucks to individuals) and a Transportation Division (that transports goods from one city to another). Some division financial measures for the year are as follows:

	Truck Rental Division	Transportation Division
Total assets	$ 11,000,000	$ 9,500,000
Current liabilities	$ 2,200,000	$ 2,800,000
Operating Income	$ 825,000	$ 855,000
Required rate of return	12 %	12%

Required:

1. Calculate return on investment (ROI) for each division using operating income as a measure of income and total assets as a measure of investment.

2. Calculate residual income (RI) for each division using operating income as a measure of income and total assets minus current liabilities as a measure of investment.

3. Tony Red, the Truck Rental Division manager, argues that the Transportation Division has âloaded up on a lot of short-term debtâ to boost its RI. Calculate an alternative RI for each division that is not sensitive to the amount of short-term debt taken on by the Transportation Division. Comment on the result.

4. Blue, whose tax rate is 40%, has two sources of funds: long term debt with a market value of $9,000,000 at an interest rate of 10%, and equity capital with a market value of $6,000,000 and a cost of equity of 15%. Applying the same weighted average cost of capital to each division, calculate EVA for each division.

5. Use your preceding calculations to comment on the relative performance of each division.

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FINE 2000 Lecture Notes - Lecture 4: Nopat, Asset, Profit Margin

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