Unformatted text preview: FINC 202 Lecture 14
Free Cash Flows + EVA + MVA 1 Operating Working Capital • Subtract Accounts Payable and Accrued Wages and Taxes (L*) 2 • • • • Cash Marketable Securities (where needed) Accounts Receivable Inventories
Operating Working Capital • Subtract L* Net Operating Working Capital • Add ______________________ 3 Problem 1 For D’Leon in 2009: a) Calculate ATCF (net cash flow)
b) Calculate the value of L* Calculate Net Operating Working Capital Calculate Total Operating Capital
4 c) d) Solution 1 5 6 Where we have been Where and where we are going and Net Cash Flows (NCF or ATCF) Operating Assets Nonoperating Assets Operating Working Capital (OWC) Net Operating Working Capital (NOWC) Total Operating Capital (TOC) Net Operating Profit After Tax (NOPAT) Free Cash Flow (FCF) Economic Value Added (EVA) Market Value Added (MVA) 7 Defining Net Operating Profit After Tax: Defining EBIT(1tC) …or “NOPAT” EBIT(1t NOPAT is a big ugly term that is simply EBIT ____________________________
• This ignores the tax effect of interest expense Which is interest income to debt investors NOPAT = EBIT ( 1 − tC ) 8 EBIT(1tC) & FCF: Why do we ignore the tax effect of Interest Expense? effect Interest expense is a component of Financing costs In NPV calculations, the cash flows in the numerator NEVER contain costs of financing • The cost of financing (including interest expense) is entered in the denominator
This is the WACC. To bring interest expense into the numerator would • have a numeratordenominator cancelling effect • _____________________________________ • FINC201’s coverage of Project Evaluation. • You evaluated annual the cash flows of a business without including interest expense. You have met this before: 9 Problem 2: D’Leon’s EBIT(1tC) 10 Operating Cash Flows (OCF) This is almost the same as ATCF • For a firm with zero debt, it would be exactly the same! Instead of using NPAT
• __________________________________ Again the important difference is that it is an Aftertax measure of income that ignores the impact of interest expense
11 OCF = EBIT ( 1 − tC ) + Depreciation + Amortization Problem 3: Calculate D’Leon’s OCF 12 Free Cash Flow (FCF)
FCF = EBIT ( 1 − tC ) − Capex + Depreciation − ∆NOWC
Noncash expense added back An accountingbased measure of net revenue available to all investors Outlays on projects excluding investment in Current Assets Increase in operating working capital required to keep the firm’s operations running
13 Problem 4
We know that D’Leon is a company that is not in good shape, although it is improving after a disastrous year in 2008. In 2009 assume that the firm is intending to take on no new investment projects and that Capex is zero.
• Actually this is not a good longterm strategy! Calculate:
a) b) c) d) L* for the 2008 year NOWC for the 2008 year Change in NOWC Free Cash Flow for 2009
14 Solution 4 15 Solution 4 continued In terms of a residual dividend policy this shows that __________________________________. However, D’Leon does pay a dividend of 22 cents per share. This dividend will have been funded out of
16 ___________________________________________ Note on Solution 4
FCF = EBIT ( 1 − tC ) − Capex + Depreciation + Amortization − ∆NOWC = 306,384 − 0 + 116,960 + 0 − 922, 270 = − $498,926 This figure drops to $376,176 if we doctor the formula to take into account the divestment of assets implied in the drop in NFA between 2008 and 2009 by entering a Capex of $122,750 But the problem said assume a Capex of zero 17 EVA: EVA: Recall the Definition of Total Operating Capital Recall Total Operating Capital is “TOC”
TOC = Net Operating Working Capital + Net Fixed Assets = ( CA − L *) + NFA ( ...or = TA − L *) Note: We assume CA does not contain non operating current assets. • If there are nonoperating current assets, remove them 18 from CA first! EVA: EVA: Definition of Return on Invested Capital Definition Return on Invested Capital is “ROIC” EBIT ( 1 − tC ) ROIC = TOC
This breaks into two useful parts: NOPAT Margin (1st term) _____________________________________ EBIT ( 1 − tC ) Sales ROIC = × Sales TOC 19 Economic Value Added (EVA) EVA is one measure of creation of value EVA is the difference between:
• the return that suppliers of finance receive • and _________________________________ • Brigham and Houston (11th Ed) does not cover EVA very well • For better coverage, see Brigham and Erhardt “Financial Management: Theory and Practice” (12eth Ed, pp 102107 20 How is EVA calculated? EVA = (ROIC WACC) × TOC
Rearrangable as: EVA = (ROIC × TOC) (WACC × TOC)
Which can be read as: EVA = NOPAT Capital Charge 21 Problem 5: Aardvark Ltd has
• • • • Longterm Debt Notes Payable Equity Total Assets $34m, $6m $60m. $110m = Total Liabilities and Equity The costs of debt (before tax) and equity are estimated as 10% and 15% respectively. Aardvark’s tax rate is 20%. EBIT is estimated at $20 million. 22 What are Aardvark’s WACC, ROIC and EVA? Solution WACC
D wd = = D+E ⇒ wS = ⇒ WACC = = = .
23 Solution EVA
EBIT ( 1 − tC ) ROIC = TOC EVA = TOC × ( ROIC − WACC ) = = = . 24 Market Value Added (MVA) Shareholder wealth is maximised by maximising the difference between: • Market capitalisation (market value of equity) • Book value of Equity MVA = (P0 x N) E E includes both • • Contributed equity capital and Retained earnings (RE) P0 x N is the Market Capitalisation of the firm
• i.e., the total market value of all ordinary shares 25 MVA continued
Example: two big USbased firms back in 1995:
CocaCola: Share price × No. shares = $US 69 billion Shareholder Investment = __________ Therefore MVA = __________ General Motors: Share price × No. shares = $US 69 billion Shareholder Investment = __________ Therefore MVA = __________ …And that was long before the current Credit Crunch and Recession 26 A Giant Falls: Giant The Bankruptcy of General Motors
The Economist June 6th12th 2009 The http://proquest.umi.com.ezproxy.canterbury.ac.n 27 ...
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 Spring '09
 WarwickAnderson
 Total Operating Capital, Operating Working Capital

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