VBM Soluion skech SS 2012: Noe: This is a soluion skech, no a complee soluion. Disribuion of poins is no binding for he correcor. 1 EVA, free cash flow, and financial raios (45) 1.1 EVA wihou adjusmens (14) NOPAT 2010 2011 Operaing income 760.00 630.00 - Provision for income axes 262.85 215.95 each - Tax shield 3.15 4.55 each ( = Tax rae * Ineres expenses) = NOPAT 494.00 409.50 Invesed Capial 2009 2010 2011 Toal asses 4,750 5,010 5,830 each - Non-ineres bearing liabiliies 410 390 440 each ( = Curren liab. - s.-. deb) = Invesed Capial 4,340 4,620 5,390 Average 2009/2010 4,480 Average 2010/2011 5,005 EVA 2010 2011 NOPAT 494.00 409.50 - Capial charges 425.60 475.48 ( = WACC * Invesed Capial) = EVA 68.40-65.98 each 1.2 Free cash flow (9) 2009 2010 2011 Curren asses 1,500 1,670 2,000 - (Curren liabiliies - s.. deb) - 410-390 - 440 Working Capial Requiremen 1,090 1,280 1,560 each Change in WCR 190 280 Free cash flow 2010 2011 Operaing income 760.00 630.00 Taxes (= Tax rae * operaing income) 266.00 220.50 NOPAT 494.00 409.50 + Depreciaion and amorizaion 1200 1400 each - Capial expendiures - 610-780 each - Changes in WCR - 190-280 each = Free cash flow 894.00 749.50
1.3 Link beween EVA and free cash flow (8) See lecure 3, slide 15: A projec creaes value if NPV > 0. [3 P] The presen value of fuure EVAs plus he value of he invesed capial is equal o he presen value of fuure free cash flows (Preinreich-Lücke): [3 P] T = 1 EVA + Invesed Capial = 0 ( 1+ WACC) ( 1+ WACC) Consequenly, using EVA for invesmen decisions arrives a he same invesmen decision as using free cash flows. [2 P] = T = 1 FCF 1.4 Working Capial (8) Working capial = curren asses curren liabiliies. Good working capial managemen reduces he working capial and herefore he invesed capial. This resuls in a higher EVA. [3 P] WC is no equally imporan in all indusries: - If he company is working on a cash basis (e.g. deparmen or grocery sores, fas food chains), i does no need a lo of WC. [2 P] - If he company sells large, expensive iems on a long-erm basis (e.g. airplanes), i needs relaively high WC. [2 P] 1.5 Liquidiy raios (6) Cash raio = (Cash + markeable securiies) / curren liabiliies = 700 / 550 = 1.27 Curren raio = curren asses / curren liabiliies = 2,000 / 550 = 3.64 These raios measure he relaion beween (pars of) curren asses o curren liabiliies. They are liquidiy raios / working capial raios. [2 P] Wih a high cash posiion, value-creaing invesmens are possible using he company s own ressources. [2 P] Alernaive: Deb/ invesors can be paid back.
2 Financial and non-financial value drivers (15) 2.1 (7) for each definiion. Alernaive definiion for capial urnover: Relaion o EVA: Toal Asse Turnover = Sales AverageToal Asses - Revenue Growh: I affecs operaing profiabiliy and consequenly he NOPAT. In conras o profiabiliy, here is no real limi for growh. [2.5 P] - Capial Turnover: I is a measure for long-erm invesmen efficiency and herefore effecs invesed capial. [2.5 P] 2.2 See lecure 9, slide 12: [2 P] each Some shorcomings of financial drivers: Shor-erm performance migh be achieved a he cos of he long run (maximizing he presen value of fuure EVAs mus be he objecive) milking asses, reduced producion qualiy a he cos of cusomer saisfacion and fuure revenues ec. Financial raios are of hisorical naure (lagged indicaors) Non-financial drivers migh help o cope wih hese problems: Leading indicaors of fuure EVA like marke share, cusomer saisfacion, produc innovaion, he number of new cusomers or employee skills and employee saisfacion migh be more under conrol of operaing managers and capure problems quicker (cusomer complains as signal of problems of produc qualiy or disribuional problems).
3 Cos of Capial (14) 3.1 Cos of Equiy (4) Cos of equiy reflecs an invesor s expecaions on he reurn for invesing in a risky asse/ in a company. [2 P] The calculaion of EVA incorporaes he WACC, and cos of equiy is par of he WACC: S B WACC = rs + rb 1 S + B S + B ( T ) C [2 P] S = marke value of equiy (sock) B = marke value of deb (bonds) r S = cos of equiy r B = cos of deb T C = corporae ax rae 3.2 CAPM (10) CAPM-formula E R! = R! + β! (E R! R! ) wih E R! = expeced reurn on he risky asse i R! = reurn of a risk-free asse β! = measure of risk of asse i (company risk facor) E R! = expeced reurn of he sock marke. [3 P] Basic idea: A risk premium needs o be paid on he reurn of a risk-free asse. This premium is dependen on he volailiy of he firm compared o he marke (refleced in β! ) on he reurns of he marke compared o he risk-free ineres rae (marke risk premium) In he CAPM, only he marke risk is incorporaed (sysemaic risk), [2 P] and no he company risk (unsysemaic risk), because he company risk is diversifiable. [2 P]
3.3 Calculaion of β A (14) Year Marke reurns Sock price firm (EUR) Reurns on firm ([0.5 P] each, max [2.5 P]) (R M R M ) 2 ([0.5 P] each, max [2.5 P]) R M R M (R A R A ) ([0.5 P] each, max [2.5 P]) 2005 100 2006 0.18 120 0.20 0.00 0.00 2007-0.10 110-0.08 0.05 0.05 2008 0.24 140 0.27 0.02 0.02 2009 0.12 155 0.11 0.00 0.00 2010 0.14 180 0.16 0.00 0.00 Σ 0.58 0.66 0.07 0.07 Mean marke reurn: 0.116 Mean reurn firm A: 0.1319 Variance (R M): 0.0167 [1.5 P] Covariance (R A,R M): 0.0172 [1.5 P] Bea firm A: 1.0335 [1.5 P] 3.4 Calculaion of cos of equiy (2) r! = 0.02 + 1.0335 0.116 0.02 = 0.119 [2 P] Wih β! = 1.1: r! = 0.02 + 1.1 0.116 0.02 = 0.126 4 Goal congruen performance measures (30) 4.1 Definiion of goal congruence (4) Managers should have incenives for value increasing decisions independenly of manager s planning horizon, discoun rae or he paricular compensaion rules [1 P]. 4.2 Profiabiliy of he projec: ne presen value (6) NPV θ = 1.400 + γ 500 θ + γ! 600 θ + γ! 800 θ NPV θ = 1.400 + θ γ 500 + γ! 600 + γ! 800 = 1.400 + 1566.35 θ [3 P] Accep he projec if θ 0.89, Consequenly: Accep projec if realized cash flows are equal o X, don accep projec if cash flows are only 80% of i. [3 P]
4.3 Calculaion of residual income using he RBCA rule (9) The par of he oal cos of invesmen (depreciaion and ineres) allocaed o period : z! = z! x =!!!! x! γ! x! RI = θ x z b 1 2 3 z 0.32 0.38 0.51 each z b 446.90 536.28 715.04 θ = 0.8-46.90-56.28-75.04 each θ = 1 53.10 63.72 84.96 each 4.4 Goal congruence achieved? (6) RI! = z! x NPV θ Each period s residual income is proporional o he projec s NPV (and hus has he same sign). In he case of θ = 0.8 (negaive NPV of he projec) he residual income is also negaive in each period. In he case of θ = 1 (posiive NPV of he projec) he residual income is also posiive in each period. If paid on he basis of such a residual income measure, he manager will hus ac in he ineres of he shareholders regardless of his own ime preferences (because he ime preference doesn maer for he decision abou he accepance of he projec if he performance measure has he same sign as he NPV of he projec in each period possibly aken ino accoun by he manager). Discoun rae of he manager differs from hose of he shareholders due o a shorer ime horizon, risk averseness and no he same access o capial markes. 4.5 Sraigh-line depreciaion (5) Wih sraigh-line depreciaion, depreciaion charge = 1,400 / 3 = 466.67 each year. Consider he case of θ = 1 (projec is beneficial for he company). Residual income in firs period: RI! = 500 466.67 0.095 1,400 = 99.67 So if he manager is paid based on residual income, and if he inends o leave he company afer he firs period, he will no inves ino he projec.