Attempts: Keep the Highest: /17 7. The relationship between the book value of shareholders' equity and the firm's Market Aa Aa Value Added (MVA) and Economic Value Added (EVA) Yesterday, Atherton Corp. released its 2015 annual report on the company's website. While reading the report for his boss, Asher came across several terms about which he was unsure. He leaned around the wall of his cubicle and asked his colleague, Tessa, for help. Asher Tessa, do you have a second to help me with my reading of Atherton's annual report? I've come across several unfamiliar terms, and I want to make sure that I'm interpreting the data and management's comments correctly. For example, one of the footnotes to the financial statements uses "the book value of Atherton's shares," and then in another place, it uses "Economic Value Added." I've never encountered those terms before. Do you know what they're talking about? Tessa Yes, I do. Let's see if we can make these terms make sense by talking through their meaning and their significance to investors. The term book value has several uses. It can refer to a single asset or the company as a whole. When referring to an individual asset, such as a piece of equipment, book value refers to the asset's , adjusted for any accumulated depreciation or amortization expense. The value, or difference between the machine's historical cost and its accumulated depreciation expense, is called its book value. In contrast, when the term refers to the entire company, it means the total value of the company's as reported in the firm's Attempts: Keep the Highest: /17 7. The relationship between the book value of shareholders' equity and the firm's Market Aa Aa Value Added (MVA) and Economic Value Added (EVA) Yesterday, Atherton Corp. released its 2015 annual report on the company's website. While reading the report for his boss, Asher came across several terms about which he was unsure. He leaned around the wall of his cubicle and asked his colleague, Tessa, for help. Asher Tessa, do you have a second to help me with my reading of Atherton's annual report? I've come across several unfamiliar terms, and I want to make sure that I'm interpreting the data and management's comments correctly. For example, one of the footnotes to the financial statements uses "the book value of Atherton's shares," and then in another place, it uses "Economic Value Added." I've never encountered those terms before. Do you know what they're talking about? Tessa Yes, I do. Let's see if we can make these terms make sense by talking through their meaning and their significance to investors. The term book value has several uses. It can refer to a single asset or the company as a whole. When referring to an individual asset, such as a piece of equipment, book value refers to the asset's , adjusted for any accumulated depreciation or amortization expense. The value, or difference between the machine's historical cost and its accumulated depreciation expense, is called its book value. In contrast, when the term refers to the entire company, it means the total value of the company's as reported in the firm's Asher That makes sense. So, what makes this value important to investors is that it is value that can change-but only due to a couple of events, including the of Treasury stock, the sale of new common or preferred shares, and the payment of . Equally important, it change in response to changes in the market prices of the firm's shares. Tessa Right! So, how useful would a firm's book value be for assessing the performance of Atherton's management? Asher Well, because Atherton's book value with changes in the market price of the firm's shares, the firm's book value reflect management's efforts to maximize the price of the firm's common stock and therefore be used to evaluate management's performance. Now, what about "Economic Value Added"? Tessa During the 1990s, the consulting firm Stern, Stewart & Company developed the concept of Economic Value Added, or EVA, to better assess management's performance in maximizing their shareholders' wealth. Atherton's EVA equals the additional profit created in excess of the after-tax operating income necessary to finance its total after-tax cost of capital, which is expressed in annual dollars. It is computed by subtracting Atherton's from its In turn, Atherton's annual cost of capital is calculated by multiplying its total operating capital, which includes its net fixed assets and net operating working capital, by the after-tax percentage cost of capital. OK, given that description, here's a question for you: Compared to the book value, what is the advantage of using the EVA to evaluate the performance of Atherton's management? Asher Give me a second to think... OK, it's better to evaluate the performance of Atherton's management by using the company's EVA rather than the book value of its shareholders' equity because the better the managerial decisions being made, the the after-tax net operating income eamed, the the difference between this net operating income and the cost of capital needed to generate that income, and the the EVA, or true economic profit, eamed by the company. Tessa Nicely done! Does this make your reading of Atherton's annual report easier