Question

Aa 11. The calculation of a firm's Market Value Added (MVA) and Economic Value Added Aa (EVA) Josh, your newly appointed boss, has tasked you with evaluating the following financial data for Western Gas & Electric Co. to determine how Western G&E's value has changed over the past year. The investment firm for which you work will make a positive (or "buy") recommendation to its investing clients if Western G&E's value has increased over the past year, a neutral (or "hold") recommendation if the value has remained constant, negative (or "sell") recommendation or a if the value has decreased. He has recommended that you use several metrics to ascertain how the firm's value has changed, and he has provided you with the following income statement and balance sheet. Western Gas & Electric Co. Western Gas & Electric Co. Income Statement Balance Sheet January 1- December 31, Year 2 December 31, Year 2 Year 1 Year 2 Year 1 Assets: Year 2 $2,200,000 $2,000,000 Cash and cash equivalents $153,900 $114,000 Sales Expenses Receivables 380,000 1,760,000 1,640,000 513,000 Inventory 897,750 665,000 EBITDA 440,000 360,000 70,000 Depreciation and amortization expense 77,000 Current assets 1,564,650 1,159,000 Net fixed assets 1,000,350 741,000 ЕBIT 363,000 290,000 Interest expense Total assets $2,565,000 $1,900,000 66,000 50,000 Liabilities and Equity: ЕВT 297,000 240,000 $285,000 Accounts payable $384,750 Tax expense (40%) 118,800 96,000 Accruals 250,088 185,250 $178,200 $144,000 Net income Notes payable 538,650 399,000 $106,920 $86,400 Common s Total current liabilities 1,173,488 869,250 Addition to retained earnings $71,280 $57,600 Long-term debt 493,763 365,750 Excludes depreciation and amortization Total liabilities 1,667,250 1,235,000 Common stock ($1 par) 179,550 133,000 Retained earnings 718,200 532,000 Total equity 665,000 897,750 Total debt and equity $2,565,000 $1,900,000 Shares outstanding 179,550 133,000 Weighted average cost of capital 7.98% 7.30% To facilitate your analysis, complete the following table, and use the results to answer the related questions. Round your percentage change answers to two decimal places Using the change in Western G&E's EVA as the decision Company Growth and Performance Metrics criterion, which type of investment recommendation Percentage should you make to your clients? Metric Year 2 Year 1 Change General Metrics A sell recommendation $2,200,000 $2,000,000 Sales A buy recommendation A hold recommendation Net income $178,200 $144,000 Net cash flow (NCF) $214,000 Which of the following statements are correct? Check all Net operating working capital (NOWC) $929,812 that apply $1.08 Earnings per share (EPS) Other things remaining constant, Western G&E's Dividends per share (DPS) $0.60 EVA will increase when its ROIC exceeds its Book value per share (BVPS) $5.00 0.00% WACC Cash flow per share (CFPS) -11.80% For any given year, one way to compute Western Market price per share $21.73 $19.75 G&E's EVA is as the difference between its NOPAT (such as $174,000) and the product of its operating capital ($1,429,750) and its weighted average cost of capital ($7.30) Investor-supplied operating capital is recorded as MVA Calculation Market value of equity 48,53% Book value of equity $897,750 $665,000 Market Value Added (MVA) $1,961,750 accounts payable, accruals, and short-term EVA Calculation investments. $217,800 Net operating profit after-tax (NOPAT) Western G&E's NCF is calculated by adding its Investor-supplied operating capital 35.00% annual depreciation and amortization expense to the corresponding year's EBITDA. 7,98% Weighted average cost of capital 7,30% Western G&E's net income is growing at a rate Dollar cost of capital 47.58% greater than its sales. This could imply that either Return on invested capital (ROIC) -7.31% its revenues are growing more quickly than its $63,695 Economic Value Added (EVA) expenses or that management is being effective in managing its costs while achieving the reported growth in sales. Other things remaining constant, either event should increase the value of the firm

Answer 1

	Formula	Year 2	Year 1	%age change (Year 2/Year 1)-1
Sales		2,200,000	2,000,000	10.00%
Net income		178,200	144,000	23.75%
Net cash flow (NCF)	Net income + Depreciation	255,200	214,000	19.25%
Net operating working capital (NOWC)	Current assets - A/C payable - Accruals	929,812	688,750	35.00%
Earnings per share (EPS)	Net income/Shares O/S	0.99	1.08	-8.10%
Dividends per share (DPS)	Common dividends/Shares O/S	0.60	0.65	-7.64%
Book value per share (BVPS)	Total equity/Shares O/S	5.00	5.00	0.00%
Cash flow per share (CFPS)	NCF/Shares O/S	1.42	1.61	-11.80%
Market price per share		21.73	19.75	10.03%
MVA calculation
Market value of equity (MV)	BV + EVA	3,901,512	2,626,750	48.53%
Book value of equity (BV)		897,750	665,000	35.00%
Market Value Added (MVA)	MV - BV	3,003,762	1,961,750	53.12%
EVA calculation
NOPAT	EBIT*(1-Tax rate)	217,800	174,000	25.17%
Investor-supplied operating capital	NOWC + Net fixed assets	1,930,162	1,429,750	35.00%
WACC		7.98%	7.30%
Dollar cost of capital	WACC*(Total equity + Notes payable + L-T debt)	154,027	104,372	47.58%
ROIC	NOPAT/Investor-supplied operating capital	11.28%	12.17%	-7.31%
EVA calculation	NOPAT - (WACC*Investor-supplied operating capital)	63,695	69,628	-8.52%

Note: There can be minor discrepancies in a few answers due to rounding off as Income Statement & Balance Sheet provided have numbers with no decimal places where as the given figures in the table above, have been computed with calculated numbers.

1). If EVA is used as a criteria then a sell recommendation should be made as its EVA is decreasing from Year 1 to Year 2.

2). Statement 1 is true - If ROIC is greater than WACC then its EVA will increase as the company will be creating value over and above the invested capital.

Statement 2 is true - EVA is calculated as NOPAT - (WACC*investor-supplied operating capital)

Statement 5 is true - Other things being constant, increase in sales or net income will increase the firm value as it will generate additional profit for the firm.

Statement 3 is false as investor-supplied operating capital equals NOWC plus net fixed assets.

Statement 4 is false as NCF is calculated as Net income plus depreciation.