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Advanced Valuation Methods Economic Profit Model Economic Profit aka EVA n n n EVA represents economic value added Reorders cash flows to allow shareholders to relate company operating performance directly to shareholder value Adjusts capital to eliminate distortions n Financing perspective Capital Debt equity n Operating perspective Capital Fixed assets working capital 2 1 Components of EVA n NOPLAT n n Capital n n Weighted average cost of capital Capital charge n n Net working capital net PP E goodwill and other assets Cost of capital n n Net operating profit after tax Cost of capital capital Economic value added n NOPLAT less the capital charge 3 What is NOPLAT Net sales Cost of sales Depreciation SG A Net Operating profit Taxes 40 NOPLAT 150 000 135 000 2 000 7 000 6 000 2 400 3 600 Excludes financing charges 4 2 What is Capital n Capital Net operating assets adjusted for certain accounting distortions n n Asset write downs restructuring charges Net operating assets Cash receivables inventory prepaids n Trade payable accruals deferred taxes n Net property plant and equipment n n Non operating assets n Marketable securities investments 5 What is the Capital Charge n n n Represents a rental charge for the use of the operating capital Minimum rate of return the operating capital should earn Calculated as the firm s weighted average cost of capital 6 3 Calculating EVA n n Two methods lead to the same answer Method 1 n EVA ROIC WACC Invested operating capital n n n n Profitability captured by the spread ROIC WACC Growth captured by the invested operating capital ROIC NOPLAT net operating invested capital Method 2 n EVA Operating profits after taxes WACC Invested operating capital n Similar to the economist s definition of profit 7 Calculating EVA An Operating Approach Net operating profit after tax NOPLAT Capital charge WACC Capital Economic value added EVA 8 4 Calculating EVA A Financing Approach NOPLAT Average capital Return on invested operating capital ROIC

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