Frequently Asked Questions on EVA
Assignment
1. I was looking at your spreadsheet for EVA and in the worksheet labeled "operating leases", I think something is fishy. In cells C33:E33 which calculates the PV factors for year 1998, 1999 and 2000, you have numbers greater than 1, in fact they are 13 and 12 and so forth. As a result, the PV of operating leases for each of those years is much greater than what it should be right? Also, in cell E33 which calculates the 2000 PV factor. Since the last payment on the lease is in year 2000, we don't really need that number and therefore the PV of leases at the end of 2000 should be zero but your spreadsheet has it as 3423077 in cell H34. Finally, Colgate has aA+ rating, but on the yields that you have provided, there is no column for A+. I looked on Damodaran's website to see whether A+ is the same as A or AA, but infact they were different categories. So where do I get the yields for A+ ratings?
Reply: I made a heroic
assumption that the “thereafter” number reported for operating leases
represents a perpetuity (I know that this isn’t correct but I wanted to see
what would happen if in fact, we assume that the operating lease is a
perpetuity… this overstates the PV of the Operating Lease). In this case, for
example, for Colgate Palmolive for the year 1997, the present value factor of a
perpetuity is 1/discount rate = 1 /.075 (since the discount rate is 7.5% for
1997). Next, since this represents the terminal value at the end of year 2005,
we multiply this PVAF by the present value factor in 2005 of .560702. Thus, the
present value factor is (1/.075)*.560702 = 7.47603. As for an A+ rating, just
use the yield for bonds rated A because it is
just a gradation.
2. Which assumption should we use with respect to the cost of goods sold to sales and SGA+RD/Sales? In the assumptions to the case on page 2, it says to use .435 for COGs/Sales and .33 for SGA+RD/Sales. However, in your spreadsheet it says to use COGS/Sales which is 48.4% in 2000 declines at 2%/year until it reaches 43.5% and then remains at this level and to use SGA/Sales which is 31.2% in 2000 increases by 1% per year until it reaches 33% and then remains at 33%.
Reply: I goofed. Please use what
is stated in the spreadsheet namely, use COGS/Sales which is 48.4% in 2000
declines at 2%/year until it reaches 43.5% and then remains at this level and
to use SGA/Sales which is 31.2% in 2000 increases by 1% per year until it
reaches 33% and then remains at 33%.
3. In calculating the EVA for each company, in row 134 of your
template you say to divide by Beg. Capital (BV) via
Operating Approach. For the year
Reply: use the numbers for
4. For the WACC*Beg. Capital via Operating Approach in row 134, is the WACC using market value or book value weights?
Reply: Use the After-tax WACC (Market Value Weights).
5. For the Stern Stewart/Quadrant Investing portion of the project, the firm LabCorp (LH) has an ROIC-WACC = 0 and a Tobin's Q less than one. That being the case, the firm could either be Value Destroying or Undervalued (b/c in those cases, Tobin's Q <1). Of course, that choice will then affect the numbers in the Quadrant Investing sheet. I placed the firm into the Value Destroying category for the purposes of completing the assignment. Can you advise what the best way to handle this is?
Reply: Place it in the UNDERVALUED group.
6. For the Valuation (%PG Sales) sheet, I have no idea how to determine the Market Value of Options Outstanding. I am destined for failure? What should I do?
Reply: Place Assume that the Market Value of Options Outstanding is zero for purposes of this case since we haven’t covered the valuation of options as of this point in time.
7. When non-operating income is negative, what should I do
because we are calculating taxes on this income? When the number is negative, is that implying
some sort of tax credit so the number should be treated just as a positive
number? This happens for CL, G, and KMB.
Reply: Assume that the negative number obtained from non-operating income after multiplying it by the tax rate represents a “tax shelter” that can be taken immediately rather than carried forward for purposes of this assignment.
8. I did not see a line for notes payable in the project template and think this is strange. In the notes, you say on pg. 685 that total capital includes market value of interest bearing short term and long term debt. So then why did you not have us include notes payable?
Reply: I should not have assumed that you would include it under current long term debt and I should have put a separate category for it. Thanks for pointing this out. Notes payable is short term debt and as such, it is one component of the “current long term debt”. In your spreadsheet, Disclosure has a separate line item for CUR LONG TERM DEBT. This is just one component of short term debt. The other component is notes payable. Thus, for the EVA calculations Current Long Term Debt = Notes Payable (if any) + Current Long Term Debt (the line item in Disclosure).
9. In the PG Valuation-%Sales template, what years are we using for the line item “Capital via Operating Approach @ MidYear”.
Reply: The comment on the page
says to use the average of
T and T+1. Set T = 2001 and T+1 = 2002.
10. What do I do about EVA in the Year 2011? Do I include it in calculating the present value of the EVA?
Reply: Although you don’t use Year 2011’s EVA directly in calculating the present value of the EVA, you will need it to calculate the terminal value. First, to calculate the WACC for the year 2011, assume that WACC for 2011 is the same as the WACC for 2010. Next, use the EVA that you calculate for 2011 and divide this number by (After-tax WACC for 2010 – Growth of 5%) to obtain the Terminal Value in Year 2010.
11. For the “Pct of Sales” template, how are you calculating the weighted average percent of sales?
Reply: Use the relative weight of beginning capital/sum of capital for Colgate-Palmolive, Gillette, Kimberly-Clark. You are not using Proctor and Gamble in the weighting process.