Attention for M.com students. share with other

1. Financial Management
Lecture No. 4
Modifying Accounting Data for
Managerial Decision

2. Modifying Accounting Data for
Managerial Decision
Financial Statements are presented in
Annual Report, Share holders and
managers use these statements, some
others stakeholders are also interest in
these statement. Stakeholders need some
modified information for corporate
decision. Financial analyst combine stock
prices and accounting data to make the
statement more useful.

3. 1st step in modifying Account is
categories of Assets
Two Categories of Assets:
1. Operating Assets:
• Assets necessary to operate Business. Operating
Assets are further divided in two categories
1. Operating Current Assets 2. Long term operating
Assets.
2. Non Operating Assets
1. Non Operating assets refers to assets above the
level of operating requirement, such short term
investment, land held by company, and cash above
the level of requirement.

4. Operating Assets and Operating Capital
Operating Current Assets:
Operating Current assets are the current assets
that are used to support operations, such as
cash, inventory and account receivable. They
do not include short term investment.
Operating current Liabilities are the current
liabilities that occur as n natural consequence
of operations, such as account payable and
accruals. They do not include notes payable
or any other short term debt that charge
interest.

5. Net Operating Working Capital
NOWC is the difference between operating
current assets and operating current
liabilities. Thus, it is the working capital
acquired with investor-supplied fund.
NOWC=Operating current assets – Operating
current liabilities
NOWC= (Cash+A/R+Inventories)- (Account
payable +Accruals)
NOWC=(10+375+615)-(60+140)
NOWC=800 million

6. Operating Long Term Assets
OLTA are the long-term assets used to support
operations, such as net plant and equipment.
They do not include any long term investment
that pay interest or dividend.
Total Operating assets (or Capital) or operating
assets/Capital, is the sum of net operating
capital and operating long-term assets. It is the
total amount of capital needed to run the
business.

7. Total operating Capital
TOC= (Net Operating working capital)+ Operating Long
term assets
TOC= 800 + 1000= 1800
Increase in MicroDrive Networking capital
NOWC(last year)= ( 15+315+415)-(30+130)
NOWC = 385 last year current 800
Total operating capital = 385+870
= 1455 Last year current 1800
Net investment in operating Asset = 1800-1455 = 345
Sale did not increase with same ratio so cash is used in
working capital.

8. Net operating profit After tax
NOPAT is net operating profit after taxes if
the company had no debt and no
investment in non-operating assets.
Because it exclude the effect of financial
decision, it is better measure of operating
performance than its net income.
NOPAT = EBIT(1-t)
NOPAT = 283.8(1-0.4) = 170.3

9. Free Cash Flow
FCF is the amount of cash flow remaining after a
company makes the assets investment
necessary to support operations. In other words,
FCF is the amount of cash flow available for
distribution to investors, sot he value of a
company is directly related to is ability to
generate free cash flow it is defined as
FCF = NOPAT – Investment in operating Capital
FCF = 170.3-345 = 174.7

10. The uses of FCF
FCF is the amount of cash available for
distribution to all investors, including both
shareholders and debt holders. There are five
good uses for FCF.
1. Pay interest to debt holders,
2. Repay debt-holders, that is pay off some debt.
3. Pay dividends to share holders.
4. Repurchase stock from shareholders
5. Buy marketable securities or other non-
operating assets.

11. FCF and corporate value
FCF is the cash available for distribution to
investors. Therefore, the value of a firm is
primarily dependent on its expected future
Free cash flow.

12. Return on invested capital
ROIC is the one way to determined whether
growth is profitable or not. If the ROIC
exceeds the rate of return required by
investors then a negative FCF caused high
growth is nothing to worry about.
If ROIC is greater than the rate of return
investors require than the firm is adding value.
This require rate of return is found as
Weighed average cost of capital. WACC
ROIC = NOPAT/Operating assets.

13. MVA and EVA
These are two more tools other than traditional
and modifying accounting data. Financial
analyst develop these two methods to
examine the maximization of the firms. These
are MVA and EVA.

14. Market value added
MVA represents the difference between the
total market value of a firm and the total
amount of investors-supplied capital. If the
market values of debt and preferred stock
equal their values as reported on the
financial statements, then MVA is the
difference between the market value of a
firm’s stock and the amount of equity its
shareholders have supplies.

15. Market Value Added
=Market value of stock –Equity capital
supplied by shareholders
Or
=(share outstanding x stock price)- Total
common equity

16. Economic value added EVA
EVA is the difference between after tax
operating profit and the total dollar cost of
capital, including the cost of equity capital.
EVA is an estimate of the value created by
management during the year, and it differs
substantially from accounting profit
because no charge for the use of equity
cpaital is reflected in accounting profit.

17. EVA
EVA= Net operating profit after tax –After
tax dollar cost of capital used to support
operations
or
=EBIT(1-corporate tax rate)-(Operating
capital )(WACC)
Or
=(operating Capital)(ROIC-WACC)

18. EVA Concepts
• In order to generate positive EVA, a firm
has to more than just cover operating
costs. It must also provide a return to
those who have provided the firm with
capital.
• EVA takes into account the total cost of
capital, which includes the cost of equity.

19. MVA and EVA for Micro Drive 2001 2000
MVA Calculation (Million Dollars) (Million Dollars)
Price per share 23 26
Number of share 50 50
Market value of equity 1150 1300
Book value of equity 896 840
MVA= Market value –Book value 254 460
EVA Calculation
EBIT 283.8 263
Tax rate 40% 40%
NOPAT= (EBIT(1-tax)) 170.3 157.8
Total investor supplied operating capital 1800 1455
After tax cost of capital WACC % 11% 10.8
Dollar cost of capital = Capital (WACC) 198 157.1
EVA= NOPAT – Capital cost (27.7) 0.70
ROIC = NOPAT/operating capital 9.46% 10.85%
ROIC – Cost of capital = ROIC -WACC (1.54%) 0.05%
EVA =Operating capital (ROIC-WACC) (27.7) 0.7

20. Depreciation
Depreciation is important tools to reduce
income tax. The larger the depreciation,
the lower the taxable income and thus the
lower the tax bill, hence the higher the
cash flow from the operation.