Corporate Finance: Newsletter - January 24, 2000



Corporate Finance: Newsletter – March 6, 2004

Where we are in class…

[pic]

Where you should be in the project…

[pic]

Data Notes…

In the next session, we will be computing a return on capital for your firm. A few issues in computing return on capital. You should be dividing the operating income in the most recent year by the book values of debt and equity in the most recent financial year. However, accounting earnings and book value may have to be adjusted for the following:

❑ If your operating income has one-time expenses and income, compute the operating income prior to these items.

❑ Your firm can have a negative book value of equity but never a negative book value for capital.

❑ The debt used in the book value calculation should be the debt you use in the market value calculation for the cost of capital.

❑ If you want a better estimate of the return on capital, you should capitalize operating leases and treat them as part of book value of capital. You should also adjust the operating income for the operating leases. The simplest adjustment that you can use is the following:

Adjusted Operating income = Operating Income + Pre-tax cost of debt * PV of operating leases.

After all these adjustments, you will get a return on capital for one year (last year). Don’t read too much into it. You may want to compute it for a number of years before you pass judgment on the company.

Miscellaneous FAQs

My firm has negative operating income. Should I still compute an EVA?

Yes. You will have a negative return on capital, which should lead to a negative EVA.

If my company has a negative EVA, is it taking bad investments?

Not necessarily, since EVA measures one year’s performance. If you have negative EVA for a number of years and you are not at an early stage of your life cycle, then you may have an investment problem.

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download