Reading 50: Security Analysis Using Value-Based Metrics - result, likely, economic, following, higher

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1.Which of the following actions is least likely to result in a consistently higher economic value added (EVA)?

A)   Postponing investment while operating at or above capacity for extended periods of time.

B)   Reduce the volatility in net operating profit after tax (NOPAT).

C)   Increase the accounts receivable turnover ratio.

D)   Reduce operating expenses.

2.Which of the following actions is most likely to result in a consistently higher economic value added (EVA)?

A)   Reduce debt by issuing new shares.

B)   Pay a special stock dividend.

C)   Repurchases shares with cash accumulated from past operating activities.

D)   Splitting the stock by a ratio of at least 2 to 1.

3.If the firm has positive net present value (NPV) projects available to invest in, the optimal strategy is to increase invested capital:

A)   only if the NPV is at least twice as large as the required investment.

B)   only if the firm’s leverage ratio will remain unchanged after funding the new project.

C)   and use that capital to invest in those profitable projects.

D)   only if dilution to existing shareholders is minimized.

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答案和详解如下：

1.Which of the following actions is least likely to result in a consistently higher economic value added (EVA)?

A)   Postponing investment while operating at or above capacity for extended periods of time.

B)   Reduce the volatility in net operating profit after tax (NOPAT).

C)   Increase the accounts receivable turnover ratio.

D)   Reduce operating expenses.

The correct answer was A)

Excess cost reduction by not investing sufficiently to retain the productive capacity of the firm’s assets will increase EVA in the short run but will negatively affect future economic profit.

2.Which of the following actions is most likely to result in a consistently higher economic value added (EVA)?

A)   Reduce debt by issuing new shares.

B)   Pay a special stock dividend.

C)   Repurchases shares with cash accumulated from past operating activities.

D)   Splitting the stock by a ratio of at least 2 to 1.

The correct answer was C)

Reducing debt by issuing shares, issuing a stock dividend, and splitting the stock will not change the total capital invested in the firm. Repurchasing shares with excess cash will reduce the total invested capital in the firm and increase the EVA.

3.If the firm has positive net present value (NPV) projects available to invest in, the optimal strategy is to increase invested capital:

A)   only if the NPV is at least twice as large as the required investment.

B)   only if the firm’s leverage ratio will remain unchanged after funding the new project.

C)   and use that capital to invest in those profitable projects.

D)   only if dilution to existing shareholders is minimized.

The correct answer was C)

If the firm has positive NPV projects available to invest in, the optimal strategy is to increase invested capital and use that capital to invest in those profitable projects. The increase in the $WACC (from higher invested capital) will be more than offset by the increase in NOPAT, and EVA will increase.