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Comprehensive Review of Economic Value Added (EVA) and Financial Metrics for Midterm Exam

This review document serves as a guide for understanding key financial concepts required for the midterm exam. It covers Economic Value Added (EVA), examining how NOPAT and the cost of capital contribute to financial performance. The text delves into risk-return tradeoffs, the valuation of bonds and stocks, and crucial financial statements. Topics include the calculation of required rates of return, understanding discounted cash flows, and exploring the relationships between various financial metrics, ensuring students are well-prepared for the exam.

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Comprehensive Review of Economic Value Added (EVA) and Financial Metrics for Midterm Exam

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  1. 173A - Review February 14, 2007Please NOTE this is not a document limiting what will be on the midterm. Anything covered in book or class is fair game. It is mostly 170 review to this point

  2. Goal: Maximize SHW (=Stock Price); Minimize Agency Conflict. EVA???? • Economic Value Added • Profit over and beyond paying for the cost of capital • $NOPAT - $Cost of Capital • NOPAT=EBIT-Taxes • $Cost of Capital = Capital (NWC+FA) * % WACC • Capital: CA-CL+FA=LTD+Equity (CA+FA=CL+D+E) • CofC: cost of debt after tax, cost of equity, impact of risk • How do you impact the components???

  3. What else • Risk Return Tradeoff= Expected Return (weighted average)= Required Rate of Return (CAPM!)= Portfolio Return/RRR (weighted average)= Expected Return = Required Rate of Return (Price?)= Undervalued vs Overvalued Securities= Fisher Effect and Impact of Inflation on RRR= Risk aversion change and RRR

  4. 0 1 2 n Value CF1 CF2 CFn Marriage of FCF and TVMDiscounted Cash FlowApplies to valuing ALL Financial Assets(Future Cash Flows & Required Rates) r ... CF CF CF 1 2 n + + + PV = . . . .       1 2 n 1 + r 1 + r 1 + r

  5. What is the value of Bond, and What is its return? • Value of bond = PVa of INT + PV of Par • What if Coupon Rate = Discount Rate • What if CR < Discount Rate • What if CR > Discount Rate • YTM, YTC

  6. Excel Solution

  7. Time and Value of 10 Yr Bond

  8. YTM in Excel

  9. YTM = Current Yield + Capital Gains Yield • ThereforeCapital Gains Yield = YTM-CY • CY = INT/Price

  10. Semiannual and Monthly Bonds 1. Multiply years by 2 to get periods = 2n. 2. Divide nominal rate by 2 to get periodic rate = rd/2. 3. Divide annual INT by 2 to get PMT = INT/2. • 1. Multiply years by 12 to get periods = 12n. • 2. Divide nominal rate by 12 to get periodic rate = rd/12. • Divide annual INT by 12 to get PMT = INT/12.

  11. Valuing Stocks and Expected Return • Constant Growth Stock • Non-constant Growth • Dividend Yield vs. Capital Gains Yield

  12. Constant Growth : P0=D1/(rrr-gr) Price in Future Year: Pn=D(n+1)/(rrr-gr)

  13. Non-constant Growth: Individual PVs plus CG PV

  14. Dividend Yield vs Capital Gains Yield • Dividend Yield = Next Div/Today’s Price • Future DY = Div (n+1)/Pn • Capital Gains Yield = (Price1-Price0)/Price0 • Future Period CGY = [Price(n+1)-Pricen]/Pricen

  15. Income Statement

  16. Balance Sheet

  17. Cash Flow Statement

  18. And Back to EVA: EVA = $ NOPAT - $CostOfCapitalCA+FA = CL+LTD+E OR (CA-CL)+FA = LTD+E • Operating Working Capital= Excludes Short Term Investments (CA)= Excludes Notes Payable (CL) • Total Operating Capital = OWC+FA • $ NOPAT = $EBIT (1-Tax%) • $ CoC = $TOC * %WACC • MVA vs. EVA? • MVA = # shares * stock price – Equity

  19. Ratios, Common Size and % change all tell the same story • Liquidity, Asset Management, Debt, Profitability • Common size: TA=100%, Sales = 100% • Percent Change: (This Year – Last Year)/Last Year • DuPont=ROE=PM*TATO*EM can start the analysis • PM measures profitability, TATO asset management, EM debt use (leverage) • Then you peel the onion further

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