Question

31. Value added to a firm Financial statements reflect only book values of the data that analysts use to evaluate a company's performance. To determine if a firm's earnings, after taxes but before the payment of interest and dividends, are sufficient to compensate both the firm's bondholders and shareholders, Stern Stewart Management Services developed an analytical technique called economic value added (EVA). EVA effectively measures the amount of shareholder wealth that the firm's management has added to the value of the firm during a period of time. If EVA is positive, then management has added value, while a negative value indicates that the firm's managers reduced the firm's value and shareholders might have earned more value by investing in some other investment with the same level of risk. Consider this case: Last year, Jackson Tires reported net sales of $80,000,000 and total operating costs (including depreciation) of $52,000,000. Jackson Tires has $83,500,000 of investor-supplied capital, which has an after-tax cost of 10%. If Jackson Tires's tax rate is 40%, how much value did its management create or lose for the firm during the year (rounded to the nearest whole dollar)? O $8,450,000 O $39,650,000 $41,750,000 O $2,535,000 You have taken a job as an entry-level analyst, and your boss has asked you to find the expected value of Monroe Manufacturing's stock. As you were doing your research, you found out that Monroe Manufacturing just paid a dividend (Do) of $3.20. The firm has experienced consistent growth of 3% for the last couple of years, and you believe that the firm will continue to grow at the same rate in the future. If investors require a return of 13% on Monroe Manufacturing's stock, what is the expected value of the company's stock? $29.66 0 $32.96 0 $26.37 $36.26

Answer 1

Economic value added = NOPAT - WACC* Capital invested NOPAT = Non operating profit after tax (80000000-52000000) *(1-0.4) 16,800,000.00 EVA = 16800000-(0.1*83500000) 8,450,000.00 hence the value created is 8,450,000.00

We will use the constant growth model formula to calculate the value of stock. Value of stock = Dividend next year/(Required rate - growth rate) 3.2*(1+0.03)/(0.13-0.03) 32.96 Hence the value of stock is 32.96 If the investors required rate of return increases to 16 % while the growth rate remains at 3% the value of stock will be 3.2*(1+0.03)/(0.16-0.03) 25.35 The change in the stock price would be 25.35-32.96 -7.61 The stock price would fall by $ 7.61