Finance and Accounting elective / SBWL Controlling Sommersemester 2012 Exam Value-based Management EXAM

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1 TECHNISCHE UNIVERSITÄT MÜNCHEN Fakultät für Wirtschaftswissenschaften Lehrstuhl für Betriebswirtschaftslehre - Controlling Prof. Dr. Gunther Friedl Finance and Accounting elective / SBWL Controlling Sommersemester 2012 Exam Value-based Management EXAM The exam consists of 4 questions (6 pages, including the cover sheet - printed duplex), all of which should be answered.

2 page 2 1 EVA, free cash flow, and financial ratios (45) The following information about a company is available: BALANCE SHEET In million, as of Dec 31 ASSETS Current assets Cash and cash equivalents Accounts receivable (trade) net Inventories Total 1,500 1,670 2,000 Noncurrent assets Intangible assets Property, plant, and equipment 2,900 3,000 3,500 Financial assets Noncurrent securities Total 3,250 3,340 3,830 TOTAL ASSETS 4,750 5,010 5,830 LIABILITIES AND EQUITY Current liabilities Short-term debt Trade accounts payable Accrued expenses Total Long-term liabilities Long-term debt Other noncurrent liabilities ,000 Total 1,250 1,270 1,660 Shareholders equity Subscribed capital Capital reserves Retained earnings 2,550 2,820 3,210 Total 2,960 3,230 3,620 TOTAL LIABILITIES AND EQUITY 4,750 5,010 5,830

3 page 3 INCOME STATEMENT In million, Jan 1 to Dec Sales 4, , Cost of Sales 3, , Selling, general and administrative Research and development Operating income Interest expense Income before taxes Provision for income taxes Net income Additional information Corporate tax rate 35.00% 35.00% WACC 9.50% 9.50% Capital expenditures (in million) Depreciation and amortization (in million) 1, , Calculate the company s EVA in 2010 and No adjustments are to be made. State the steps of your calculation. (14) 1.2 Calculate the company s free cash flow in 2010 and Do this by starting with operating income. (9) (Hint: working capital requirement needs to be calculated for 2009, 2010 and 2011; for the calculation of WCR, assume that all cash and cash equivalents are operating cash.) 1.3 Why is the EVA a value-based performance measure? In your answer, please refer to the link between EVA and free cash flow. (8) 1.4 Define working capital. What is the relation between working capital management and EVA? Is working capital equally important in all industries? Explain. (8) 1.5 Calculate the company s cash ratio and current ratio for What do these ratios measure and to which category of ratios do they belong? Name and briefly explain one advantage of a high cash position. (6)

4 page 4 2 Financial and non-financial value drivers (15) 2.1 Define Revenue Growth and Capital Turnover. Explain their relationship to EVA. You can use a value-tree driver in your explanation. (7) 2.2 Name and briefly explain: two shortcomings of financial value drivers. two reasons for the use of non-financial value drivers. (Hint: Different answers are expected for the two parts of the question.) (8)

5 page 5 3 Cost of capital (30) 3.1 Define cost of equity. Show where it appears in the calculation of EVA (4). 3.2 One approach to estimate cost of equity is the CAPM (capital asset pricing model). Name the formula and explain what the components of the formula are. Explain the basic idea of the CAPM. In your answer, also address the difference between systematic and unsystematic risk and how both are accounted for in the CAPM (10). 3.3 The following data shows the stock price development of firm A as compared to the market performance of the market in which firm A has been operating over the last five years. Year Market returns Stock price firm A (EUR) Determine the CAPM-beta of firm A relative to the industry stock market. Use the five year data given above. The formula for beta is given by is defined as the covariance of the company s returns and the stock market returns, and is defined as the variance of the stock market returns, each calculated over the five year period. (Hint: Use the formula for the variance and covariance as used in the tutorial.) (14) 3.4 Calculate the cost of equity of the company using the CAPM and calculated in 3.3 (if you do not have a result for, assume ). Assume a return on a risk free asset of 2%. (2)

6 page 6 4 Goal congruent performance measures (30) Consider a company which has to decide, at date t = 0, about the acceptance of an investment project to launch a certain product. The project needs an initial investment of b at t = 0 and has cash flows at time t = 1, 2, 3. The vector represents the intertemporal pattern of the future cash flows. The parameter fixes the actual magnitude of the cash flows and reflects the market success of the product. The company s cost of capital is. The amount of the initial investment is given by. The vector of the project is given by. There are two possible outcomes of the project: The realized cash flows can either equal or - if the product is not as successful as expected be only 80% of it. 4.1 Provide a definition of goal congruence. (4) 4.2 Determine the decision rule for accepting the project from the company s perspective dependent on. Is it advantageous for the company s shareholders to undertake the project in each possible state of the market? (6) 4.3 Suppose now that the state of the market,, is private information to a divisional manager. The company s headquarters only knows the vector. The divisional manager decides about the realization of the project on the basis of his compensation. The manager s compensation is based on residual income in the periods t = 1, 2, 3. For calculating residual income the concept of the relative benefit cost allocation rule is adopted. The weights thereby represent the shares of depreciation and interest payments of the initial investment assigned to period t. Calculate the weights. Then calculate residual income in each period for both possible values of. (9) 4.4 Will the manager decide in the interest of the company s shareholders when applying the relative benefit cost allocation rule? Why? Refer to the manager s time preferences. Name two reasons why a manager s time preferences usually differ from a company s time preferences. (6) 4.5 For the case of realized cash flows being equal to, illustrate that the use of straight-line depreciation can set a wrong incentive for the manager. (Hint: You only need to calculate residual income for the first period.) (5)

Finance and Accounting elective / SBWL Controlling Wintersemester 2012/ 2013 Exam Value-based Management Feb. 21, 2013 EXAM

TECHNISCHE UNIVERSITÄT MÜNCHEN Fakultät für Wirtschaftswissenschaften Lehrstuhl für Betriebswirtschaftslehre - Controlling Prof. Dr. Gunther Friedl Finance and Accounting elective / SBWL Controlling Wintersemester