Wacc

$WACC invested capital net operating profit after tax after-tax weighted average cost of capital in decimal terms

marginal tax rate dollar cost of capital net working capital + net fixed assets book value of long-term debt + book value of equity

Professor's Note: Notice the difference in calculation between residual income and EVA. Residual income is net income (after subtracting interest expense) minus a charge for equity capital based on the cost of equity. EVA is NOPAT (before subtracting interest expense minus a charge for debt and equity capital based on the WACC). Conceptually, however, they are both measuring economic income.

The analyst should make the following adjustments to the financial statements before calculating NOPAT and invested capital:

• Capitalize and amortize research and development charges (rather than expense them), and add them back to earnings to calculate NOPAT.

• Add back charges on strategic investments that will generate returns in the future.

• Capitalize (but do not amortize) goodwill, add amortization expense back to earnings to get NOPAT, and add accumulated amortization back to invested capital. These adjustments are imporrant if the financial statements are prepared using IAS. Under the new rules for U.S. GAAP, goodwill is nor amortized; instead, ir's subject to an annual impairment test.

• Eliminate deferred taxes and consider only cash taxes as an expense.

• Treat operating leases as capital leases and adjust nonrecurring items.

Market value added (MVA) is the difference between the market value of a firm's long-term debt and equity and the book value of invested capital supplied by investors. It measures the value created by management's decisions since the firm's inception. MVA is calculated as:

MVA = market value - invested capital

Example: Calculating EVA and MVA

VBM, Inc., reports NOPAT of $2,100, a WACC of 14.2%, and invested capital of $18,000. The market price of the firm's stock is $25 pet share, and VBM has 800 shares outstanding. The market value of the firm's long-term debt is $4,000. Calculate VBM s EVA and MVA.

Answer:

First calculate EVA:

$WACC = 0.142 x $18,000 = $2,556 EVA = $2,100 - $2,556 = -$456

The market value of the company is the market value of the equity plus the market value of the debt:

The firm's MVA is:

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