In assignment 2, I was assigned to find the relationship between Free Cash Flow (from now on refer as FCF), Economic Value Added (from now on refer as EVA) and Market Value Added (from now on refer as MVA), specifically whether a company with high FCF also have high EVA and MVA. Explanation using empirical evidence is also needed to support my reasoning and arguments. Therefore, in order to complete this assignment, I have used a few types of references which are financial management reference books, journals, articles from Fortune magazine and set-up an interview with Mr. Amiruddin b. Abdul Shukor which is the Chief Financial Officer (CFO) for Nationwide Express Courier Services Berhad. Throughout his career, he had worked in Permodalan Nasional Berhad (PNB), Permodalan Terengganu Berhad (PTB), Securities Comission Malaysia (SC) and Malaysian Industrial Development Finance Berhad (MIDF). An interview session was set with him on 2/12/2011 at his office in the headquarters of Nationwide Express Courier Services Berhad in Shah Alam, Selangor.
2.1Free Cash Flow
In definition, FCF is the cash flow actually available for distribution for investors after the company has made all the investment in fixed assets and working capital necessary to sustain ongoing operations (Brigham & Ehrhardt, 2005). Basically, the formula for FCF is as follows:
In the investors’ perspective, positive value of FCF is more favorable than negative value because it means that the company has high expectancy of generating available cash in the future. As for the managers’ of a company, positive FCF reflect their ability in managing cash within the firm (Amiruddin, 2011). However, in some cases, negative FCF is not always bad. FCF value can be negative due to the reason that the NOPAT value is high. This situation occurs when the company is experiencing rapid growth which means that there is a significant increment in the operating expenses which caused the NOPAT value to be significantly high and result in negative FCF. This scenario usually happens in startup companies or companies that are incurring significant current expenses to launch new product line (Brigham & Houston, 1999). However, this situation usually lasted for a short-term and the FCF value will eventually produce a positive value in the future. Therefore, it is good to have profitable growth although it contributes to negative FCF (Brigham & Houston, 1999).
2.2Market Value Added
For MVA, it is defined as the difference between the market value of the firm’s stock and the amount of equity capital that was supplied by the shareholders. This will result in maximizing of shareholders’ wealth (Brigham & Ehrhardt, 2005). The formulas for MVA are as follows:
Basically, the goal of MVA is to maximize the shareholders’ wealth and this can be achieved through maximizing the value of MVA. The higher the MVA value is, the better the job management is doing for the firm’s shareholders (Brigham & Ehrhardt, 2005). This is due to the reason that, with high MVA, shareholders can trade their share at a higher price and obtain more profit. Therefore, in the investors’ point of view, it is the job of the management team to create value in the market to ensure higher stock price is being traded. For the firms’ point of view, higher MVA can ensure higher stock price which also means higher capital being invested in the company (Amiruddin, 2011).
2.3Economic Value Added
EVA is defined as the managerial effectiveness in a given year (Brigham & Ehrhardt, 2005) or a measure of how much the management has added to shareholders’ wealth during the year (Brigham, Houston, Yao, Hon & Bany, 2010). EVA can be calculated using the following formula:
EVA is an estimate of the true economic profit of the year and it represents residual income that remains after the cost of all capital including equity capital has been deducted (Brigham & Ehrhardt, 2005). EVA...