Deck 13: Measuring and Managing for Shareholder Value

Question 1

Why is the treatment of a loan in the SVA model is consistent with the long-term horizon of SVA?

A) The book value of long-term liabilities is consistently used.
B) Present value of planned future debt financing and a terminal value for estimates outside the planning range are used.
C) The market value of debt used is consistent with the market value of the earnings represented by the discounted FCFs.
D) Loans are assumed to be rolled over in perpetuity.
E) The treatment of loan capital is a weakness as it is not consistent with the long-term horizon of SVA.

Answer 1

C

Question 2

For what reason is a higher discount rate is often used when performing Shareholder Value Analysis (SVA)?

A) To weight future cash flows more heavily than current cash flows.
B) When the desire is to project a more optimistic scenario.
C) To avoid overestimating the value of the business to the shareholder.
D) When returns from capital projects are not expected to be achieved in the short term.
E) When factors that impact cash flows are less predictable.

Answer 2

E

Question 3

What is a significant disadvantage to EVA?

A) Once calculated, it is difficult to interpret correctly.
B) It can be unfairly biased by company size.
C) It is not directly comparable to the EVA of another company.
D) It is not directly comparable to the EVA of a previous period.
E) It can be unfairly biased by the liquidity of the company.

Answer 3

C

Question 4

What is a common adjustment made to calculate EVA from a company's audited financial statements?

A) The addition of goodwill to total assets.
B) The addition of restructuring costs to operating expenses.
C) The subtraction of marketable securities' income from operating expenses.
D) The inclusion of advertising costs in total assets and its depreciation.
E) The addition of an allowance for doubtful accounts to invested capital.

Question 5

Pelisse Packaging Ltd. has a cost of capital of 12%. The company's balance sheet at year end shows current assets of $2.2 million, capital assets of $6.1 million, current liabilities at $1.3 million, long-term liabilities of $4.1 million, shareholders equity of $2.9 million. Its income statement for the year shows sales revenue of $5.1 million, cost of goods sold of $2.1 million, salaries of $500,000, marketing and promotions of $350,000, administration expense of $300,000, rent expense of $100,000, and depreciation of $100,000. Non-operating income and expenses included interest expense of $250,000 and new product development costs of $550,000. Income taxes amounts to $230,000. Marketing and promotions are expected to impact revenues in this year and next, and the results of the new product development for an infinite period. After performing the common adjustments to the accounts, what is the EVA for Pelisse?

A) $563,600
B) $663,600
C) $833,600
D) $1,011,600
E) $1,550,000

Question 6

A company has a periodic expense for depreciation of $150,000 a month. Its accumulated depreciation for the period ending December 31 of the year just ended is $18 million on capital assets of $55 million. Based on this information, what adjustment is need when calculating free cash flows?

A) $0.00
B) $150,000
C) $1.8 million
D) $18 million
E) $55 million

Question 7

What do Discounted Free Cash Flows represent?

A) Income available for distribution to shareholders.
B) Opportunity cost to shareholders of another corporation of equal risk.
C) Cash available for distribution to shareholders and lenders.
D) Economic value of the business.
E) The equivalent of the total market value of the assets of the business.

Question 8

A company currently has $6.1 million in free cash flows and expects to have $8.4 million in the last year of its 5-year plan. If its weighted cost of capital is 12%, and its tax rate is 25%, what is its terminal value?

A) $30.3 million
B) $33.6 million
C) $38.1 million
D) $52.5 million
E) $70.0 million

Question 9

What is o ne of the reasons why Shareholder Value Analysis (SVA) is based upon Net Present Value (NPV) Analysis?

A) NPV considers expected return for level of risk in its calculation.
B) NPV can be modified to accommodate changes in accounting procedures.
C) NPV uses only actual, current, measurable data in its calculation.
D) NPV is easy to calculate and to interpret and is widely used..
E) NPV considers the size of the business in its calculation.

Question 10

What calculations always have to be made to the value of EVA to achieve the same value as SVA?

A) Capital invested would be added to the NPV of future EVA flows from which the market value of debt would be subtracted.
B) Find NPV of future EVA flows as these are equivalent to free cash flows, and then follow the same as calculating SVA.
C) Since SVA is based on non-traditional accounting methods and EVA is based on traditional financial statements, the measures will always be incompatible.
D) Delete adjustments to debt, assets and equity and follow the steps for finding SVA.
E) Add the market value of debt to the NPV of future EVA flows.

Question 11

What is one of the main reasons why managers are making shareholder interests paramount?

A) To conform to changes in securities legislation.
B) To attract shareholder funds in a highly competitive environment.
C) Because of pressures from non-governmental regulatory agencies such as the Canadian Securities Commission.
D) Because of activism from pressure groups composed of large numbers of small individual investors.
E) Because managers' interests almost always coincide with those of shareholders.

Question 12

For the year just ending, Elena Electronics Inc. had sales revenue equal to $950,000, cost of goods sold $399,000, selling expenses $191,000, distribution expenses of $70,000, administration expenses of $62,000, depreciation expense $18,000, interest charges $44,000 and taxes at $57,000. During that year there was an increase in accounts receivable of $10,000 and no capital asset were purchased. What was the free cash flow generated for the year?

A) $117,000
B) $161,000
C) $171,000
D) $321,000
E) $557,000

Question 13

What is a reason why supporters of SVA believe that EPS is not a valid measure of shareholder value?

A) EPS does not include consideration of the interest earnings of lenders.
B) EPS includes estimated future profits that are, as yet, unearned.
C) EPS is based on market values rather than the more conservative book values.
D) EPS does not consider the future value of the shares.
E) EPS relies on share price rather than solely on quantifiable internal measures.

Question 14

Free cash flows for the four-year planning horizon for Amherst Confectionery Co. Ltd. are projected to increase by $200,000 each year from a Year 1 base at $1.2 million. The company's bonds and mortgages have a market value of $2.7 million and the company's cost of capital is 8%. What is the value of Amherst Confectionery Co. Ltd to its shareholders?

A) $7.9 million
B) $18.7 million
C) $21.4 million
D) $24.7 million
E) $27.4 million

Question 15

What is a significant problem with using conventional accounting measures of profit, or profit-based ratios?

A) All sources of revenue to the business are not considered in traditional methods.
B) Electronic data processing methods are demonstrating that these measures are obsolete.
C) Accounting measures include the opportunity cost of shareholder equity, understating net income.
D) There is often a mixture of historic values with current market values in the calculations.
E) Risk, a qualitative intangible, is a factor in the calculation of income.

Question 16

When is a company is successfully increasing shareholder's wealth?

A) Only when EVA is lower than the period before.
B) When EVA is higher than market capitalization.
C) When EVA is negative.
D) When EVA stays within one z-score of mean earnings.
E) When EVA is positive.

Question 17

What is a value driver that a Human Resources manager could impact directly?

A) Working Capital
B) Taxes
C) Operating Costs
D) Fixed Capital
E) Sales.

Question 18

Grayson Scaffolding Inc. has a cost of capital of 9% and the following free cash flow projections over their five-year planning horizon: $3.4 million, 3.8 million, $4.5 million, $4.9 million, and $5.2 million. Using free cash flows, what is the total business value?

A) $28.4 million
B) $37.5 million
C) $54.2 million
D) $57.8 million
E) $74.4 million

Question 19

A company has a weighted average cost of capital of 11%, EBIT of $3.4 million, gross assets of $20.2 million, current liabilities of $6 million, and accumulated depreciation of $4 million. The company pays interest of $650,000 and has a tax rate of 34%. What is the company's Economic Value Added (EVA)?

A) $1.3 million
B) $1.6 million
C) $2.0 million
D) $2.3 million
E) $3.1 million

Question 20

Cardomaine Seaway Inc. is looking to make a share bid for Laker Transportation's 20 million common shares. Laker is struggling to turn the company around and carry a debt at a market value of $30 million. Laker's cost of capital is 9%. Sales revenue for this year is expected to be $50 million and Cardomaine believes Laker will be increasing it by 5% annually for the next four. Operating expenses are 75% of sales revenue with depreciation expenses equalling investment in replacement assets. Income taxes can be estimated at 24% of operating income. The company has published plans of additional asset investment at $5 million this year, $5 million next year and $7 million in each of the following three years. Working capital is 30% of sales revenue and the company expects to drop this by $3.2 million this year with additional declines of $3.2 in each of the following four years. What price per share would Cardomaine offer Laker's shareholders that would leave them as well off as before?

A) $2.76
B) $3.28
C) $4.13
D) $5.41
E) $6.35

Question 21

Which of the following demonstrates a growth strategy for the creation of shareholder wealth?

A) Reducing salary expense of inside sales representatives by creating a self-service web site.
B) Improving the operating cash cycle through Just-In-Time raw materials delivery from suppliers.
C) Instituting recycling and recovery processes to reduce waste and cut costs.
D) Replacing old equipment with newer equipment providing higher quality and yield.
E) Creating a product development process that ensures new products make up a specified proportion of the total product line.

Question 22

A company has a business value of $2,075,000, a weighted average cost of capital of 14%, and invested capital of $1,250,000. The company's EVA for its most recent period is $47,200. What proportion of the company's business value is contributed to by growth?

A) 8.4%
B) 9.7%
C) 16.2%
D) 20.1%
E) 23.5%

Question 23

Jericho Paper Distributors has a stable share of a saturated regional market. If the company's EVA is expected to continue at $7.2 million indefinitely, its capital invested is $3.1 million, and its cost of capital is 8%, what is the total business value?

A) $144.2 million
B) $93.1 million
C) $41.5 million
D) $10.3 million
E) $9.8 million

Question 24

A large company has profiled its current customer database using over 150 characteristics including size, credit rating, frequency of purchase, value of purchases, speed of payment, etc. The resulting model predicts with significant accuracy the likelihood of new customers becoming loyal customers. The company has restructured its commission system to reward sales persons who sign up customers matching the computer profile. The bonus is based on the net present value of expected future purchases less a factor for estimated length of collection period. Which measure of shareholder wealth is this performance reward system most consistent with?

A) Total Shareholder Return (TSR)
B) Traditional accounting methods
C) Market Value Analysis (MVA)
D) Shareholder Value Analysis (SVA)
E) Economic Value Added (EVA)

Question 25

Simithy Medical Disposal is a new and expanding entry in the bio-waste/bio-hazard industrial sector. As of year-end it had $50 million in invested capital of which $40 million is long-term debt. Simithy Medical's 2 million shares trade for $45 each. The company has an EVA of $8.3 million and a cost of capital of capital of 12%. Assuming book value of debt equals market value, what is Simithy's Future Growth Value (FGV)?

A) $10.8 million
B) $20.8 million
C) $69.2 million
D) $249.2 million
E) $350.1 million

Question 26

What will EVA and MVA be if a business generates returns equal to the firm's cost of capital?

A) Both will be zero.
B) EVA will exceed MVA.
C) MVA will exceed EVA.
D) EVA will be positive.
E) MVA will be positive.

Question 27

Five years ago, Pandura Chemicals was incorporated issuing three million common shares at $12 each. At the company's inception, it also issued $10 million of 20-year bonds at a face value of $1000 and with a coupon rate of 8% and annual payments. Today, the company's shares trade at $22 each and bonds for a company with the same risk rating are issued at 6%. Pandura's retained earnings equal $7 million. Recalculating debt to reflect market values, what is Pandura's Market Value Added (MVA)?

A) $21.1 million
B) $23.0 million
C) $24.9 million
D) $25.3 million
E) $38.9 million

Question 28

What is the best way to measure changes in shareholder value?

A) Consider the changes in the company's balance sheet measured at fair value.
B) Consider the changes in the company's share price, dividend policy, and fair value of its bonds.
C) Consider long term cash flows taking into account risk and the cost of sharehoders' equity.
D) Consider the problem that accounting policies may vary from company to company.
E) Consider the problem that ratios based on profit do not take in to account all the costs of capital invested by the business.

Question 29

What is the critical feedback loop to determine whether shareholder value has been created?

A) Measure shareholder returns.
B) Focus on maximizing shareholder returns.
C) Determine an appropriate shareholder return measure.
D) Recognize the importance of shareholders.
E) Set appropriate objectives for shareholders.

Question 30

Business 1 has a total market value of $500 million and total capital invested of $350 million. Business 2 has a total market value of $850 million and total capital invested of $570 million. Business 3 has a total market value of $700 million and total capital invested of $420 million. Business 4 has a total market value of $680 and total capital invested of $460. Business 5 has a total market value of $500 million and total capital invested of $220. Use MVA and any other calculation necessary to find which business provides the highest wealth creation.

A) Business 1
B) Business 2
C) Business 3
D) Business 4
E) Business 5

Question 31

Social Games Ltd. has a business value of $50 million, capital invested of $32 million, and annually generates returns that exceed investors required returns by $4 million. What is the percentage required return demanded by investors?

A) 8.0%
B) 12.5%
C) 18.0%
D) 22.2%
E) 64.0%

Question 32

Why may EVA be considered a better measure for rewarding managers than SVA?

A) EVA can be fine-tuned to measure an individual's performance.
B) EVA is not as easily manipulated by managers as SVA.
C) EVA values are more comparable from period-to-period than SVA.
D) EVA does not include estimates of future performance.
E) EVA focuses managers on current profits rather than long-term gains.

Question 33

Air Ltd. has operating costs equal to 40% of sales. Air Ltd. is forecasting two scenarios. Scenario 1 is that operating costs will rise 10% but taxes will decrease 10%. Scenario 2 is that operating costs will decrease by 10% and taxes will increase 10%. Which scenario would have the biggest impact on free cash flow?

A) Scenario 1, which will increase cash flows by 2.1%.
B) Scenario 2, which will increase cash flows by 2.7%.
C) Scenario 1, which will decrease cash flows by 2.1%.
D) Scenario 2, which will decrease cash flows by 2.7%.
E) Both scenarios will impact free cash flows equally.

Question 34

Which of the following is generally true about shareholder value analysis and economic value added?

A) Shareholder value analysis provides a more useful reference for developing manager's bonus rewards systems.
B) Economic value added is more practical to use and generates the same results as shareholder value analysis.
C) Shareholder value analysis does not require the development of entirely new systems in order to be implemented.
D) Economic value added uses conventional financial statements and makes extensive adjustments in order to calculate value.
E) Economic value added deducts the present value of future shareholder value analysis and the market value of debt to calculate value.

Question 35

What is the total shareholder return (TSR) if Calico Clothing's share price over the past year increased from $25.40 to $28.50 and the company paid out dividends of $1.65 per share?

A) 18.7%
B) 16.7%
C) 5.7%
D) -5.1%
E) -5.7%

Question 36

Harry Hermes Delivery Service's has been restructured to stem losses. The company's EVA for the year just ending was ($300,000). In its medium range plan Harry Hermes has projected EVA for the following three years to be ($150,000), $25,000, and $500,000, respectively. If the company's weighted average cost of capital is 10%, what is the gain or loss in shareholder value over the period?

A) ($36,408)
B) ($40,055)
C) $23,622
D) $75,000
E) $185,168

Question 37

Which of the following companies is most committed to the shareholder value approach?

A) Company A, when it decides to expand from a microchip manufacturer to an on-line internet company.
B) Company B, a bank that acts on opportunities to buy other distressed banks cheaply in order to grow its deposit base.
C) Company C, an auto company that focuses on cost cutbacks and pension rollback to improve the bottom line.
D) Company D, a software company that introduces to its mission statement shareholder values initiatives such as salary freezes.
E) Company E, a shipping company that makes short term investments of free cash flows in oil and gas companies.

Question 38

Lavalle Design Systems Ltd. owns computer equipment that cost $10 million. It expects to use the equipment for 10 years and sell it for $100,000. Lavalle rents everything else. Lavalle generated sales of $10 million in the year just ended and has an operating profit margin of 30%. Lavalle faces a 20% tax rate. During the year working capital was reduced by $4 million and additional equipment worth $3 million was purchased at year end. What was Lavalle's free cash flow for the year assuming straight line depreciation is used?

A) ($3,610,000)
B) $990,000
C) $2,390,000
D) $3,400,000
E) $4,390,000

Question 39

Hard Drinks Ltd., a social software company, expects sales to be $20 million next year, $24 million the year after, $28 million in the following year, before settling down to $30 million thereafter. Operating profit margins are fixed at 20%. The corporate tax rate is 40%. Replacement capital asset investments will exceed depreciation by $1 million per year. Working capital will be reduced by $100,000 each year. New capital asset investment will be $500,000 each year. If Hard Drinks cost of capital is 10%, what is its total business value?

A) ($39.8)
B) $5.1
C) $18.6
D) $44.7
E) $145.3

Question 40

The Board of Directors of Hospitality Corp. is meeting to decide on the company's fourth quarter dividend. For the first three quarters of the year dividends per share have been $0.30, $0.33, and $0.40. The company's stated policy is to provide shareholders with a total annual return of 30%. Given that the share price started the year at $25.00 and end the year at $30.00, what size dividend should the Board declare?

A) $0.52
B) $1.04
C) $1.47
D) $2.51
E) $5.02