Ch 03: Assignment - Financial Statements, Cash Flow, and Taxes Tristan That makes sense. So, what makes this value important to investors is that it is an expected future 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 dividends . Equally important, it will change in response to changes in the market prices of the firm's shares. Annie Right! So, how useful would a firm's book value be for assessing the performance of Extensive's management? Tristan Well, because Extensive's book value changes with changes in the market price of the firm's shares, the firm's book value can reflect management's efforts to maximize the price of the firm's common stock and therefore should not be used to evaluate management's performance. Now, what about "Economic Value Added"? Annie 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. Extensive'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 Extensive's from its In turn, Extensive's annual cost of capital is calculated by multiplying its total investor-supplied 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 Extensive's management? ess for ation Tristan Give me a second to think... OK, it's better to evaluate the performance of Extensive'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 greater the after-tax net operating income earned, the less the difference between this net operating income and the cost of capital needed to generate that income, and the greater the EVA, or true