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Financial Statements - Investor and Management Views

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Compare and contrast the differing views an investor and management may have on financial statements. How should investors and management view EVA and FCF? Pick a publically traded company. Go to the company Web site. Try one that you are familiar with?you shop at their store, eat at their restaurants, or wear their clothes. On their Web site, try to find their annual financial report. If you cannot find it on their site do an Internet search. Sometimes these are found under Investor Relations on a company's site. Yahoo finance is also a good source. If you still cannot find the annual report, try another search until you find one (for example, search for "GAP Annual Report"). Search for the economic profit, EVA, and free cash flow in the firm's annual report, and discuss your findings. Discuss the firm's operations as indicated by their annual report. You must submit your backup in Excel or other supporting documentation showing how answers were reached.

EVA=EBIT (1-T)- (Total investors capital x after-tax cost of capital)
Free Cash Flow = EBIT(1-T) + Depreciation - (Capital Expenditures+ Increase in Net Working Capital)

Please cite sources.

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Economic Value Added vs. Free Cash Flows

Admittedly, there are different users of the financial statements. These users also have different reasons in analyzing the statements. For example, investors would analyze them to determine whether their investments in the firm should be retained, sold or even added to. This implies then that users of financial statements have also differing views on major financial metrics such as the economic value added and free cash flows.

To be more specific, management views EVA as a capital budgeting decision making tool. Using EVA allows management to identify the economic profit of an investment. Unlike net income, EVA takes into account the opportunity cost of capital. The ...

Solution Summary

The expert compares the views an investor and management may have on financial statements. How investors and management view EVA and FCF is determined.

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Multiple Choice: Capital, IRR, Relevant cash flows, Financial risk, Dividend irrelevance, Sale of new stock, Preferred stock, Cash Management, Risk Management, Bankruptcy law

1. Capital can be defined as the funds supplied by investors.

a. True
b. False

2. The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs) with the present value of the cash inflows.

a. True
b. False

Relevant cash flows
3. When calculating the cash flows for a project, you should include interest payments.

a. True
b. False

Financial risk
4. Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used.

a. True
b. False

Dividend irrelevance
5. MM's dividend irrelevance theory says that dividend policy does not affect a firm's value but can affect its cost of capital.

a. True
b. False

Sale of new stock

6. When new common stock is offered for sale to the public through investment bankers, the investment bankers may provide potential investors with informa¬tion contained in a statement called the

a. Indenture.
b. Trust agreement.
c. "Red herring" prospectus.
d. Proxy.
e. Security agreement.

Preferred stock
7. Which of the following statements concerning preferred stock is most correct?

a. Preferred stock generally has a higher component cost to the firm than does common stock.
b. By law in most states, all preferred stock issues must be cumulative, meaning that the cumulative, compounded total of all unpaid preferred dividends must be paid before dividends can be paid on the firm's common stock.
c. From the issuer's point of view, preferred stock is less risky than bonds.
d. Preferred stock, because of the current tax treatment of dividends, is bought mostly by individuals in high tax brackets.

Cash management
8. Which of the following statements is most correct?

a. A good cash management system would minimize disbursement float and maximize collections float.
b. If a firm begins to use a well-designed lockbox system, this will reduce its customers' net float.
c. In the early 1980's, the prime interest rate hit a high of 21 percent. In 1995 the prime rate was considerably lower. That sharp interest rate decline has increased firms' concerns about the efficiency of their cash management programs.
d. If a firm can get its customers to permit it to pay by wire transfers rather than having to write checks, this will increase its net float and thus reduce its required cash balances.
e. A firm which has such an efficient cash management system that it has positive net float can have a negative checkbook balance at most times and still not have its checks bounce.

Risk management
9. Which of the following are not ways in which risk management can increase the value of a company?

a. Risk management can increase debt capacity.
b. Risk management can help a firm maintain its optimal capital budget.
c. Risk management can reduce the expected costs of financial distress.
d. Risk management can help firms minimize taxes.
e. Risk management can allow managers to maximize their bonuses

Bankruptcy law

10. Which of the following statements is most correct?

a. Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that time.
b. Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are governed solely by state laws.
c. All bankruptcy petitions are filed by creditors seeking to protect their claims on firms in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm's management.
d. Chapters 11 and 7 are the most important bankruptcy chapters for financial management purposes. If a reorganization plan cannot be worked out under Chapter 11, then the company will be liquidated as prescribed in Chapter 7 of the Act.
e. "Restructuring" a firm's debt can involve forgiving a certain portion of the debt
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