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25 Mar 2019

Financial analysts have developed two performance measures: Market Value Added (MVA) and Economic Value Added (EVA). Discuss and explain both. Which is a better representative of the firm’s performance, and why?

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Beverley Smith
Beverley SmithLv2
27 Mar 2019

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PROBLEM 12-10. Economic Value Added and the Balanced Scorecard [LO 6,7,8] Spectrum Book Company has two divisions:The Brick and Mortar division sells books through more than 100 bookstores throughout the United States; the Internet division was formed 18 months ago and sells books via the Internet.Data for the past year are:

Brick and Mortar Internet Division Division

Total assets $162,000,000 $15,480,000

Noninterest-bearing current liabilities 7,020,000 2,520,000

Interest expense 1,260,000 418,500

Net income (loss) 27,810,000 (1,125,000)

Tax rate 40% –0–

Cost of capital 10% 12%

Required

a. Evaluate the two divisions in terms of economic value added (EVA).

b. Explain why it might be better to evaluate the Internet division in terms of a balanced scorecard rather than just using EVA.

c. Consider the customer and internal processes dimensions of the balanced scorecard. Suggest two measures for each dimension that would be appropriate for the Brick and Mortar division and two measures for each dimension that would be appropriate for the Internet division.

d. A strategy map diagrams the relationship across the dimensions of the balanced scorecard. Identify the potential links between the customer and internal processes dimensions you identified in part c.

What is the market price of a share of stock for a firm that pays dividends of $1.20 per share, has a P/E of 14, and a dividend payout ratio of 0.4?

The Market Value Added (MVA) is the ____.

  1. indicator of how successful a firm has been at increasing its financing its assets
  2. return on total capital minus cost of capital
  3. indication of an increase in operating efficiency
  4. positively related to the present value of all expected future EVA.

For our purpose, Shareholders' Value Maximization will be the preferred goal for all of the following reasons EXCEPT:

  1. The shareholders' value maximization goal deals with accounting profit, while the profit maximization goal attempts to make cash available to meet financial needs.
  2. Shareholders' value maximization is a long-run goal and the public image of the corporation may be of deep concern to shareholders including the wealth effect
  3. The effects of all financial decisions are reflected in the price of the stock being traded in efficient markets
  4. The complexities and uncertainties in the external environment are all absorbed in the value of the stock.

Choice 1 is 100 percent stock options with a four-year vesting schedule and a 10-year life. Choice 2 is 50 percent stock options and 50 percent performance shares, which are based on the company’s total shareholder return compared with the S&P 500 over a three-year period.

"The first two choices are catering to people who are willing to roll the dice," Herman says, adding that the payouts are vulnerable to market conditions.

The third and fourth choices are quite different. They are based on "economic value added," a metric devised by Best Buy that uses an internal formula that changes from year to year. They involve the meeting of one-year performance targets, but employees can’t access the rewards for three years.

Choice 3 offers 50 percent stock options and 50 percent restricted stock, which is awarded at the end of three years for performance measured against the company’s economic-value-added goal at the end of 2007. Choice 4 offers 50 percent restricted stock and 50 percent performance units, both earned at the end of three years, based on company performance against the economic-value-added goal at the end of 2007.

It might sound like a lot of delayed gratification, but at the end of 2007, employees can clearly see what they will get three years later, Herman says.

1. why do you think so many of Best buy executives opted for choice 1 or 2? What would you do to encourage more employees to adopt choices 3 and 4?

2. does this best buy compensation program satisfy line of sight requirements? Which of the four choices do you think has the most direct line of sight?

3. what additional compensation elements would you add to the best buy compensation package?

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