ACCA P4 Advanced Financial Management
Sample Study Note
For exams in June2014
1
www.accaapc.com
© Lesco Group Limited, April 2015
All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without the prior written
permission of Lesco Group Limited.
2
www.accaapc.com
Sample Note Content:
Main study note content [Total Pages: 218] ...................................................... 4
Product Summary .......................................................................................... 5
Live online note sample plan ........................................................................... 6
Live online course timetable: ........................................................................... 7
Free cash flow ............................................................................................. 11
Adjusted Present Value(APV) ......................................................................... 17
Business Valuation ....................................................................................... 31
Please note:
This is just the sample study note extracted from the main study note in your tuition study
[This tuition study note is consistent in basic/super/gold package]. There would be more
chapters in the main study note covering the whole ACCA syllabus.
You can also take a look at the content within the main study note below:
3
www.accaapc.com
Main study note content [Total Pages: 218]
Chapter1 Financial Crisis & Corporate Governance
-Why financial crisis
-corporate governance
Chapter 2 Accounting Equation: Assets=liability+Equity
Sessoin1 Assets
-session1.1 Domestic investment appraisal
-session1.2International investment appraisal
-session1.3Business Valuation
-session1.4Risk Management
Session2 Liability+Equity
-session2.1 Financing decision
-session2.2 Dividend Policy Decision
Chapter 3 How to grow and save your business?
-session3.1 International Trade
-session3.2 Mergers & Acquisitions
-session3.3 Business Reorganization and Reconstruction
Chapter4 Other current issues
4
www.accaapc.com
Product Summary
content
ACCA HD quality super tuition videos
ACCA HD quality super revision videos
Last minute revision
ACCA Live online tuition(4sessions)
ACCA Live online revision(14hours)
ACCA Mock exams(with tutor mark)
ACCA Tutor support
ACCA Electronic study note
ACCA Student online forum
Pass Guarantee
ACCA Final revision mock exam paper
ACCA Super Live online session (2030hours)
ACCA Super Live online revision
(Super 3 days)
ACCA 1V1 Career Advice
ACCA Extra exam techniques
demonstration
Live online mentoring
5
www.accaapc.com
Basic
Super
Gold
package
package
Package
Oxford Brookes BSc in Applied Accounting
Live online note sample plan
Live online tuition note plan for June2014 P4 Exam
[Only for super / gold package (there would be a unique plan for gold package)]
Live sessions: [2 hours/session---live online + recorded after class]:

Live session1 topic: Investment appraisal Summary

Live session2 topic: Financing decision + Business Valuation Summary

Live session3: Risk Management Summary

Live session4: overall summary of knowledge in P4 exam
Live revision note for June2014 P4 exam: [will be available since mid April 2014]:

Live revision1+2: [There would be a separate live revision note detailing all
past exam questions with answers to go through]
6
www.accaapc.com
Live online course timetable:
Live session/revision for F4-P7
7
www.accaapc.com
8
www.accaapc.com
*Please Note: This Timetable may be subjected to future changes.
Kindly check regularly for any possible updates.
9
www.accaapc.com
Domestic investment appraisal
The idea behind this is to use techniques to evaluate whether the investment
proposal is worthwile.
Techniques would be classified between:
Non-discounting techniques
Payback period
Discounting techniques
Net present value(NPV)
Other decisions
Asset replacement
Capital rationing
Lease or buy decision
Free cash flow
Risks&Uncertainty
Sensitivity analysis
Monte Carlo simulation
Value at risk
Option pricing model
Real option
Black-Scholes
option pricing
model
Accounting rate of return(ARR/ROCE/ROI)
Adjusted present value
Internal rate of return(IRR)
Discounted payback period
Duration/ Macaulay Duration method
Modified internal rate of return(MIRR)
10
www.accaapc.com
Free cash flow
Free cash flow to firm is cash flow
from operations+ interest expense cash flow from investing activities.
Free cash flow to equity is free cash flow-interest expense(net of tax)-net debt
borrowing.
Once we have calculated the free cash flow to equity we can then establish the
dividend cover based on free cash flow to equity. We have learnt how to calculate
dividend cover where we take PAT/Dividend paid. But before PAT is profit and it’s
subject to manipulation by management so we can use a cash flow approach to do
this.
11
www.accaapc.com
There are 2 ways to calculate free cash flow to equity:
Direct method:
PAT
x
Adjustment for non cash item
x
Adjustment for changes in working capital
x
-cash flow from investing activities
x
Adjustment for net debt borrowing
x
Free cash flow to equity
x
Indirect method:
Free cash flow
x
-interest paid(net of tax)-because in free cash flow we have subtracted the whole taxes
x
Adjustment for net debt borrowing
x
Free cash flow to equity
x
Free cash flow needs to be assessed not in a single period because sometimes
company would spend money into expanding the business in the current year so
the current year’s free cash flow would be low but it does benefit the company for
the long term.
12
www.accaapc.com
Example Human Ltd
The following statement of profit or loss relates to Human Ltd.
$m
Sales
90
Cost of sales
(30)
Gross profit
60
Operating expense
(20)
PBIT
40
Interest
(10)
PBT
30
Tax@20%
(6)
PAT
24
During the year loan repayments are expected to amount to $20 million.
Issue of new debt is $69m.
Deprecation charge is $30 million and capital expenditure is $10 million.
Human ltd bought $3 inventory during the year.
Human Ltd ha 100m shares in issue and DPS is $0.03.
13
www.accaapc.com
Required:
1, calculate free cash flow to firm
2, calculate free cash flow to equity
3, calculate dividend cover using free cash flow to equity method.
14
www.accaapc.com
Answer:
1, FCF to firm:
PBIT
40
Tax at 20% on PBIT
(8)
32
Depreciation
30
Working capital
(3)
Capital expenditure
(10)
FCF to firm
49
15
www.accaapc.com
2, FCF to equity:
Indirect method:
FCF to firm
49
-interest net of tax(10x(1-20%))
(8)
Adjustment to net debt borrowing
49
(69-20)
FCFTE
90
Direct method:
PAT
24
Adjustment to non cash item
30
Depreciation
Adjustment to working capital
(3)
CAPEX
(10)
Adjustment to net debt borrowing
49
(69-20)
FCFTE
90
3, dividend cover: = FCFTE
Dividend value
= 90
100mX0.03
=30times
16
www.accaapc.com
Adjusted Present Value(APV)
APV is used when you are appraising
a project where its financial risk is
changed.
We have looked at NPV calculation and we use WACC(weighted average cost of
capital) to discount cash flow.
WACC has incorporated debt and equity element and one of the arguments for this
is future sales, costs incurred have nothing to do with financing but instead they
are something to do with operations.
So that’s why we developed APV to separate business option from financing.
APV is used when you are appraising a project where its financial risk is changed.
This means we use cost of equity(ungeared) to discount the basic cash flow
including revenue & expenses because they are something to do with business not
finance.
17
www.accaapc.com
We can then establish present value of finance effect including issue cost, tax
saving on interest and subsidy as well and for these items we use risk free rate/cost
of debt to discount because APV doesn’t specify which discount rate we should
choose and you can argue that eg, for tax saving on interest we have no idea when
tax rate may change and as a result we can use Rf or Kd to discount the cash flow.
Here notice you can either use Rf or Kd to discount cash flow and whichever you
use your examiner would give you a mark in the exam(although your answer may
be different from examiner’s and that’s totally acceptable).
18
www.accaapc.com
Calculation:
APV=
Base case NPV
+
PV of Finance Effect
Only include relevant cash flow from operations



Issue costs
Tax savings on interest
Subsidy
Discount factor would only include BR(Keu)
But when Co is geared(2approach to separate (Keu))
M&M preposition
2 cost of equity
Beta
Keg=Keu+(Keu-Kd)D(1-T)
Geared
Ungeared
E
3 WACC
WACC(g)=WACC(ungeared)(1-Dt )
(Keu)
D+E
1,
ungeared
E+D(1-T)
2,CAPM
19
www.accaapc.com
βa= βe [ E ]
Keu=rf+βa(Rm-Rf)
Keu=rf+βa(Rm-Rf)
PV of finance effect calculation:
Issue costs:
1, % X amounts raised(not amounts required)
2, net off with tax saving
3, discount them
Tax saved on interest:
1, interest expense
2, multiply by tax rate
3, discount it
Subsidy:
1, PV of tax shield on interest
2, PV of subsidy(amounts saved net of tax because save interest=save expense so
increase in tax )
20
www.accaapc.com
Base Case NPV Example1:
Company A is an equity finance company with Ke=10%.
Company B is considering a project that would cost $100,000 to be financed 50%
by equity (ke= 21.6%) and 50% by debt (kd(pre-tax) =12%).
Required:
Calculate Keu for company A and company B.
Answer:
Company A: Keu=10%
Company B:
Keg=Keu+(Keu-Kd)D(1-T)
E
21.6% =Keu +(Keu-12%) X 50X(1-30%)
50
Keu=17.6%
21
www.accaapc.com
Base Case NPV Example2:
Company has the following market value of finance:
Value of debt is $6m.
Value of equity is $11.8m.
Company’s current WACC is 19.7%.
Tax rate is 30%.
Required:
Calculate Keu for company.
Answer:
WACC(g)=WACC(ungeared)(1- Dt )
(Keu)
D+E
19.7% =WACC (ungeared) X 1- 6X30%
6+11.8
WACC(ungeared) (Keu)=21.9%
22
www.accaapc.com
Base Case NPV Example3:
Company diversifies its business by entering into the mining industry.
The company’s equity beta is 0.85, and its financial gearing is 60% equity, 40%
debt by market value.
The average equity beta in the mining industry is 1.2, and average gearing 50%
equity, 50% debt by market value.
Tax rate is 30%.
The risk free rate is 5.5% per annum and the market return 12% per annum.
Required:
Calculate Keu.
Answer:
1,
ungeared
βa= βe [ E ]
E+D(1-T)
βa=1.2 x 50
50+50X(1-30%)
=0.71
2,CAPM
Keu=rf+βa(Rm-Rf)
23
www.accaapc.com
Keu=5.5%+0.71X12
%=10%
Base Case NPV Example4:
Company has an equity beta of 0.85 and asset beta of 0.5.
Rf=5%
Rm=10%
Required:
Calculate Keu.
Answer:
Keu= Rf+βa(Rm-Rf)
=5%+0.5x(10%-5%)
=0.075
24
www.accaapc.com
Example: (JOJO Ltd) (issue cost)
CAPEX required: $20m
How to raise $20m: from a 1 for 3 rights issue at a price of £2 per share.
Right issue cost: 5%.
Rf: 10%.
Required:
Calculate issue cost to be incorporated into APV calculation where:
1, issue cost is not a tax allowable expense
2, issue cost is a tax allowable expense and tax is paid 1 year in arrears while tax
rate is 30%.
25
www.accaapc.com
Answer:
1,
Amounts raised – issue costs = amounts required
100%
5%
95%
20m
20/0.95
=21.05
21.05-20=1.05
21.05X5%
DF@yr 0= 1.05X1=1.05
APV= base case NPV - 1.05
2,
DF@10%
Issue cost = 1.05 (1)
Tax saved: 30%X1.05 =0.315
yr0
yr1
PV
1
(1.05)
0.909
(0.73)
APV= base case NPV - 0.73
26
www.accaapc.com
0.32
Example: TT Ltd (tax saving on interest)
CAPEX required: $10m.
How to raise $10m: use a 5 year bank loan(year1-5) and interest expense is 10%.
Tax is paid 1 year in arrears at 30%.
Rf=10%.
Required:
Calculate tax saving on interest to be incorporated into APV calculation.
Answer:
1, interest 10%X$10m=$1m.
2, tax saved: 30% X$1m= $0.3m
3, discount it:
1 year in arrears based on year 1-5
$0.3X AF(YR2-6) @10%
$0.3XAF1-6 XDF(yr 1-5)@10%
=0.3X 1/0.1 X(1-1/1.1^5)X0.909
=0.3X3.791X0.909
=1.03
So APV=base case NPV + 1.03
27
www.accaapc.com
Example: SS ltd
CAPEX required=$20m
Company would normally borrow at 8%
Government has offered a loan at 6%(which is lower than market rate)
Risk free rate=5%
Project is for 5years
Tax rate is at 30% paid in the current year.
Required:
Calculate subsidy to be incorporated into APV calculation.
28
www.accaapc.com
Answer:
1, PV of tax shield on interest
$20m X6%X30% XAF@5%(1-5yr) = 1.56
4.33
2, PV of subsidy
Subsidy %= 8%-6% =2%
Total subsidy p.a.= 2% X$20m=0.4
PV of subsidy(net off tax) 0.4X(1-30%)XAF@5% 5yrs =1.21
APV=base case NPV +1.56+1.21
29
www.accaapc.com
Comment of APV
1, Difficult to choose an appropriate discount rate for side effect, ie, tax shield.
2, when establish the discount rate for base case NPV, ie, Keu, the beta factor is
based on M&M assumptions.
30
www.accaapc.com
Business Valuation
In this session we are going to
look at how to value a
business.
Session overview:
1.
2.
3.
4.
5.
Reasons to value a business
Types of valuation methods
Payment methods
Defense
Regulation regarding takeover
31
www.accaapc.com
Reasons to value a business
The 1st question is why do we need to value a business?
Well, the reasons being:
We want to acquire another company so we need to determine how much we are
going to pay for them.
For listed companies you would notice they have their own share price then we can
take it multiply by number of shares giving us total market capitalization then why
do we still need to value them?
The reason is because we are in a semi market hypothesis so the share price
quoted may not include insider information then we need to do extra calculation to
verify whether that share price is the value of the company.
Other reason includes eg, why we need to value the company would be company
may want to go listed onto the stock exchange then how would you determine your
share price? Of course you need to value it first then divide by the number of
shares and hence you can get share price you are going to quote.
Or we would like to merge another company(Co1+Co2=Co1) or acquire another
company in order to make it become a subsidiary, eg, creating synergies(1+1>2)
so we need to understand how much it’s worth before we purchase it.
32
www.accaapc.com
Types of valuation methods
The 2nd question being how we can value a business?
There are three types of valuation including type1, type2 and type3.
Type 1 acquisition means after acquiring this company the existing business risk
and financial risk would not change.
Type 2 acquisition means after acquiring this company the existing business risk
would not change but financial risk changes.
Type 3 acquisition means after acquiring this company both business risk and
financial risk change.
33
www.accaapc.com
Type 1 acquisition
We are going to use book value approach, market based approach and cash flow
based approach to value the business.
1. Book value approach
The simple idea is to look at total equity within statement of financial position BUT
that figure doesn’t include up to date information like:
Replacement cost: cost of setting up the same business now.
Net realizable value: value to sell something now.
Potential intangible assets: slogan, brand name etc.
And we need to subtract goodwill in the valuation process as well.
After we’ve looked the above things we need to consider how to value an
intangible asset.
34
www.accaapc.com
Example: Hum ltd
Hum has the following elements within its FS:
$
Non-current assets:
PP&E
100
Goodwill
30
Other intangible assets
20
Current assets:
Inventory
10
Receivable
15
Total equity
150
Total liability
25
Note:
 The property, plant and equipment have a replacement value of $50.
 30% of the inventory are no longer required by Hum ltd and they can only be
sold to customers for $2.
Required:
Calculate the valuation for Hum Ltd based on its net asset method.
35
www.accaapc.com
Answer:
$
Non-current assets:
PP&E
50
Goodwill
30
Other intangible assets
20
Current assets:
Inventory
10-3+2=9
Receivable
15
Total equity
150
Total liability
25
Asset excluding goodwill - liability =39(net assets)
50-30+20+9+15
-25
After we’ve looked at how to value a business using net assets approach then we
can start thinking about how to value its intangible assets because we know that an
asset can be recognized in its FS if it’s identifiable (price agreed between two
parties) but for company name, slogan, relationship with customers, they are not
identifiable and how can we come up with a value for those items?
And for goodwill(the excess we paid for the reputation, slogan and relationship of
company) maybe that’s not worth this value and how can we value this as well?
36
www.accaapc.com
We use:
 CIV approach(calculating intangible value)
 Market to book value
The simple idea behind CIV approach is we compare:
Average operating profit
Average assets base
With industry figure and the excess amount would be due to the value of intangible
assets.
The simple idea behind market to book value approach is to compare:
Book value of equity with market value of equity(share priceXnumber of shares)
And the excess amount would be due to the value of intangible assets
37
www.accaapc.com
Example: Independence Ltd(CIV)
Average profit before interest and tax of Independence Ltd is $66.2.
Average assets of Independence Ltd are $230.
Average Pre-tax return on asset in the industry is 20%.
Tax rate is 30%.
Cost of capital is 11%.
Required:
Calculate the value of intangible assets using CIV approach.
Answer:
Return on asset of Independence Ltd is 66.2 =29%
230
Excess return=ROA of independence – industry average
=29%-20%=9%
Intangible asset value before tax=9%X230=21
Value of intangible asset after tax=21X(1-30%) =134
11%
38
www.accaapc.com
Example MB plc
At the year end the book value of total equity of MB ltd is $200m.
Share price as at the year end is $20 and there are 20m shares in issue.
Required:
Calculate the value of intangible assets.
Answer:
MV=$20X20m=$400m
BV
=$200m(include any possible replacement cost/NRV is necessary)
So the value of intangible assets=MV-BV=$200m.
39
www.accaapc.com
2. Market based approach
Under market based approach we are going to use
 P/E ratio
 Dividend yield model
to value a business.
After looking at the above techniques we can start thinking about why
valuing high growth company is very difficult?
Well firstly most of these companies are loss making and hence using P/EXloss per
share to value them becoming market price? Well this is difficult.
Secondly maybe these companies don’t have much cash to pay to shareholders and
hence when using dividend valuation model to value a company because Do=0 so
Price of company=0?
40
www.accaapc.com
P/E ratio
This is useful when value a business for majority shareholders.
Share value=
earnings
Target company
X
P/E
acquirer
There are some limitations when using this method:
1, for earnings for target company, are you going to use the average earnings over
5years? 3years? Or are you going to use current year earnings?
2, for P/E ratio, if the target company is a listed company then P/E can be obtained
from share market but what if the target company is not listed? So you may need
to adjust the P/E using your own experience, expertise or you can take a company
in the similar industry to adjust it.
Here’s a very simple example to show how it works:
41
www.accaapc.com
Example: Pipi Ltd
Sisi plc wants to acquire Pipi ltd and profit after tax of Pipi ltd is $300 whilst P/E
ratio of a company in a similar industry with Pipi is 6. And P/E of Sisi plc is 8.
Required:
What is the value of Pipi Ltd?
Answer:
Share value=P/E
Sisi plc
42
www.accaapc.com
X
earnings=8X$300=$2,400
Pipi Ltd
Dividend yield basis
Dividend yield=
DPS
X100
Share price
This is one of the ways to maximize shareholders wealth and for listed companies
this can be taken out from stock market.
This is often greater than interest rate because if this is not the case, from
shareholders’ perspective why bother taking additional risks to invest money in
shares but instead they can put their money directly into banks and enjoy a higher
return.
We use this method to value a business normally unlisted but we can
reasonable estimate the dividend per share of that company.
So share price of target company =
DPS(target Co)
Dividend yield (similar listed Co)
Example: Don ltd
Gun plc wants to acquire an unlisted company called Don ltd. Don has 10m shares
in issue and expects to pay out a total dividend of $300,000.
Dividend yield of a company in the same industry of Don Ltd is 2%.
Required:
Calculate share price of Don Ltd using dividend yield basis.
43
www.accaapc.com
Answer:
share price of target company =
DPS(Don Co)
Dividend yield (similar listed Co)
= $300,000/10m
=$1.5/share
2%
Maybe we can further adjust $1.5/share by reducing it by 30% because
it’s unlisted companies? But this is based on industry experience and
expertise.(just a guess work)
44
www.accaapc.com
3. cash flow based approach
 dividend valuation model(dividend growth model)
 free cash flow method
 Economic value added(EVA)
45
www.accaapc.com
Dividend valuation (growth) model
Here we are focusing on perpetuity whereby we are going to take future
dividend(cash element) discounted at ungeared cost of equity.
In simple terms this is the PV of future dividend at cost of equity ungeared.
Note: this is future dividend not current dividend.
This is useful when value a business whereby shareholders hold a minority stake
because they tend to prefer dividend rather than capital gain.
Future dividend would remain constant or would grow.
If it’s constant then
Po= D
Ke
If it’s with growth then
Po= Do(1+g)
Ke -g
Notice:
1. Po is ex dividend because we need to consider the net effect after paying out
dividend to shareholders and forms ke to our company.
2. g is dividend growth rate not earnings growth rate.
3. If examiner tells you to value a business using DVM cum dividend then you need
to take Po + g.
46
www.accaapc.com
Comment:
Advantage:
It’s useful when valuing a company for minority shareholders.
Disadvantage:
When calculate growth rate etc using CAPM then disadvantages associated with
CAPM would also apply.
47
www.accaapc.com
Example: DIDI plc (DVM Model)
1, DIDI plc expects to pay a constant annual dividend of 45c per share and the
market expects a rate of return of 15%.
2, DIDI plc expects to pay dividend of 30c next year and dividend growth rate is
5% whilst earnings growth rate is 10%. Ungeared cost of equity is 10%.
3, DIDI plc expects to pay dividend of 30c next year and dividend growth rate is
5% and the market expects a rate of return of 15% and what is the cum dividend
value of share?
4, Current dividend of DIDI plc is 30c and dividend growth rate is 5%. Risk free
rate is 5% and market rate of return is 10% and beta is 1.3.
5, DIDI plc expects to pay dividend of 30c next year. Ungeared cost of equity is
10%. Dividend in 4years ago was 20c per share and now is 25c per share.
6, DIDI plc expects to pay dividend of 30c next year. Ungeared cost of equity is
10%. DIDI plc has an accounting rate of return of 11% and pays out 35% of its
profit after tax as dividend each year.
7, DIDI plc has a DPS of 30c and has just paid out whilst dividend growth is
expected to be 10% in the next 2 years and 5% in year 3. DIDI plc estimates a 3%
growth of dividend till perpetuity after year3. Ungeared cost of equity is 5%.
Required:
Using DVM calculate share value of DIDI plc.
48
www.accaapc.com
Answer:
1, Po=$0.45 =$3/share
15%
2, Po=
$0.3
=$6/share
10%-5%
3,Po+Dividend =
$0.3
+$0.3=$3.3/share
15%-5%
4, Po=
$0.3X(1+5%)
= $4.85/share
5%+1.3X(10%-5%) -5%
5, g=(current dividend
)^1/4 -1 =(25/20) ^1/4 -1 =5.7%
Dividend 4 yrs ago
Po=
$0.3
=$6.98/share
10%-5.7%
6, g=11%X(1-35%)=7%(Gordon’s growth method)
Po=
$0.3
10%-7%
49
www.accaapc.com
=$10/share
7,
Years
Dividend
DF @5%
PV
1
30X(1+10%) =33
0.952
31c
2
30X(1+10%)^2=36
0.907
33c
3
36X(1+5%)=38
0.864
33c
$0.97
Year4 dividend into perpetuity=38x(1+3%)=$20/share
5%-3%
X year3 discount factor
Year 3value
X
0.864
$17/share
So total share value=$0.91+$17=$17.91/share
50
www.accaapc.com
Free cash flow Basis
This is again perpetuity approach to discount future free cash flow at discount
factor.
There’re 2 free cash flow from the previous study:
 Free cash flow to firm (cash available to debt and equity holders)
 Free cash flow to equity(cash available to equity holders)
If there’s no grow of cash flow we can use:
PV= FCFo -value of debt
WACC
PV=FCFTE
Ke
If there’s cash flow growth then we can use DVM model like:
PV= FCFo(1+g) -value of debt
WACC-g
PV=FCFTE(1+g)
Ke -g
Notice: g is cash flow growth rate or you can use inflation rate as well.
51
www.accaapc.com
Example Nente Co(June2012 Q1)(adjusted)
Free cash flow of Nente Co is $1,180. Free cash flow in 3 years ago was $970 and
now is $1,230. It’s expected that growth rate will reduce to 25% of the original rate
for the foreseeable future. Weighted average cost of capital is 11%.
Value of debt from statement of financial position is 6,500.
Number of shares of Nente Co is 2,400shares.
Required:
Using free cash flow to firm approach calculate current value of a Nente Co
share.
Answer:
PV= FCFo(1+g) -value of debt
WACC-g
=1,180X(1+0.0206) -6,500
0.11-0.0206
=$13,471-$6,500
=$6,971
Share price=$6,971/2,400shares =$2.9/share
g=(1230/970)^1/3
=0.0823
X25%=0.0206
52
www.accaapc.com
Economic Value Added(EVA)
Free cash flow approach just looks at valuation of a company as at a point in time,
ie, discounting future cash flow to the present value and if the company has spent
money into buying non-current tangible and intangible assets then the total cash
flow would decrease and hence value of the firm and share would decrease as well.
But for economic value added method we are going to focus on a period rather than
just a point in time. We are going to take profit-cost associated with finance and
make LOTS OF adjustments(in the real life there are more than 160 adjustments
we need to make).
Calculation：
EVA=
net operating profit after tax
-(WACC X capital employed)
Operating profit(1-T%)
Or PAT + int net of tax
NOPAT:
Operating profit(before tax)
X
-Operating profitXCT%
(X)
Normal operating profit after
tax
X
Adjustments:
Non cash items-depre/amotisation
X
Research expenses
X
Training costs
X
Interest expense net of tax
X
Operating leases
X
Net operating profit after tax
53
www.accaapc.com
X
Capital employed:
long term debt+total equity *
*there are lots of adjustments in the real life but in the p4 exam your examiner
tends not to complicate these issues but in p5 you can expect some other
adjustments to be made like capitalized operating leases etc.
54
www.accaapc.com
Example: EVA plc
The statement of profit or loss for EVA plc is as follows:
2013-2014($m)
Sales
80
Other Expenses
(10)
Training costs
(10)
research costs
(10)
Interest expense
(10)
PBT
40
Tax expense @30%
(10)
Profit after tax
30
The statement of financial position of EVA plc is as follows as at 2014:
2014($m)
Total Assets
100
Equity
Ordinary shares($1 par value)
30
Retained earnings
20
Total equity
50
Long term liabilities-traded debts
40
Current liabilities
10
Total equity and liabilities
100
WACC is 5%.
Required:
Using EVA to value the EVA plc and the value of EVA plc share.
55
www.accaapc.com
Answer:
Operating profit
40
-Operating profitXCT%(40X30%)
(12)
Normal operating profit after
tax
28
Adjustments:
Research expenses
10
Training costs
10
Int net of tax(10X0.7)
7
Net operating profit after tax
55
Capital employed=LTD+equity=40+50=90
EVA=net operating profit after tax-(WACC%Xcapital employed)
=55-(5%X90)
=
50.5
-value of debt
(40)
Total value of firm 10.5m
Number of shares 30m
Share price
56
www.accaapc.com
$0.35/share