Value Based Management in Relation to Shareholder Value Analysis and Economic Value Added

This document explains the concepts and principles of value based management in relation to shareholder value analysis (SVA) and economic value added (EVA). It discusses the importance of creating value, managing for value, and measuring value in order to increase the value of companies and maximize shareholder value. The document also provides references for further reading.

Business Finance
Investments

Table of Contents
MAIN BODY...................................................................................................................................3
Question 2 Calculation of net cash flows and NPV. ...................................................................3
Question 3. Multiple choice questions.........................................................................................4
Question 4. Explanation of concepts and principles of value based management in relation to
shareholder value analysis (SVA) and economic value added (EVA)........................................6
REFERENCES................................................................................................................................7

MAIN BODY
Question 2 Calculation of net cash flows and NPV.
(a) Preparation of net cash flows:
Cash flow – The term cash flow can be defined as in and out flow of cash during a particular
time period. Herein, below as per the given data of Poly-day plc cash flow is computed which is
as follows:
Statement of cash flow :
Particulars 2011 2012 2013 2014
Sales £40,00,000.00 £80,00,000.00 £80,00,000.00 £40,00,000.00
Less: Purchase of data-master
plant -£2,50,000.00 -£2,50,000.00 -£2,50,000.00 -£2,50,000.00
Less : Variable expenses -£12,00,000.00 -£24,00,000.00 -£24,00,000.00 -£12,00,000.00
Less : Fixed cost -£10,00,000.00 -£20,00,000.00 -£30,00,000.00 -£40,00,000.00
Less : Investment in additional
plant -£40,00,000.00 £0.00 £0.00 £0.00
Less : Depreciation -£7,60,000.00 -£6,15,600.00 -£4,98,636.00 -£4,03,895.16
Add : Disposal of plant £0.00 £0.00 £0.00 £10,00,000.00
Add : Tax allowance £8,10,000.00 £6,56,100.00 £5,31,441.00 £5,31,441.00
Add : Changes in creditors £1,20,000.00 £2,40,000.00 £2,40,000.00 £1,20,000.00
Less : Changes in stock trades -£2,40,000.00 -£4,80,000.00 -£4,80,000.00 -£2,40,000.00
Less : Changes in Debtors -£6,00,000.00 -£12,00,000.00 -£12,00,000.00 -£6,00,000.00
Net cash flow -£31,20,000.00 £19,50,500.00 £9,42,805.00 -£10,42,454.16
Net present value as per the above calculated cash flows :
Net present value – It can be defined as an investment appraisal technique which is used by
companies to compute the present value of investments. Below as per the above calculated cash
flow, the net present value is calculated which is as follows :
Year Cash flow
Present value
factor Discounted cash flows
0 -£10,00,000.00 0.15 -£1,50,000.00

2011 -£31,20,000.00 0.8695652174 £27,13,043.48
2012 £19,50,500.00 0.7561436673 £14,74,858.22
2013 £9,42,805.00 0.6575162324 £6,19,909.59
2014 -£10,42,454.16 0.5717532456 -£5,96,026.55
Net present value £40,61,784.74
Analysis – The net present value is of £40,61,784.74 on the basis of present value factor of 15 %.
This can be analysed that making investment in new product for above Poly-day plc can be
beneficial.
(b) Sensitivity of the decision reached in the above part (a) to assumed corporation tax rate.
On the basis of above part of question, this can be stated that net present value of above
poly-day company's product's net present value is of £40,61,784.74. This is indicating that
making investment in this new product can be beneficial because its current value seems to be
beneficial for futuristic time period. In addition, the rate of corporate tax is of 30 % as per the
given information so on this tax rate the value of net present aspect is computed. As well as the
amount of net present value is computed by considering 15 % PV factor. Basically, in the
absence of computation of net present value of possible alternatives this can be difficult to
evaluate future efficiency. So overall, making investment in the new produced device can be
useful for above chosen Poly-day company.
Question 3. Multiple choice questions.
(1) Of the following two statements :
I. “Real” assets include such things as land, buildings and machinery.
II. “Financial” assets include such things as loans made to government and shares in other
businesses.
Answer : Statement 1 is true and statement 2 is true, therefore option (4) is right.
(2) An investor owns shares in a business that currently have a market value of £2.50 each. He
pays £0.40 per share to buy an option that will entitle him to sell the shares for £3.00 each in six
months' time. If in six months' time the shares have a market value of £3.50 each, the value of
the option (per share) would be :

Answer : Nothing so option (1) is right.
(3) To be relevant to a particular decision an item of data needs to be :
Answer : Relate to the future and to the objective being pursued. Thus, option (2) is right.
(4) In the context of business finance, the expression “agency costs” relates to :
Answer : The cost to shareholders of managers not acting in the shareholders' best interest. So
option (2) is right.
(5) Which is the only one of the following that is a necessary assumption of the separation
theorem :
Answer : Returns from the investments are known with certainty. Therefore option (1) is correct.
(6) The P/E ratio is:
Answer: The share price divided by the dividend paid per share so option (4) is correct.
(7) A business is considering an investment which will generate a cash flow in exactly five year's
time. The discount rate associated with the investment is 15% per annum. To deduce the present
value of the projected cash flow, we have to multiply the amount of the cash flow to be received
in five years' time by:
Answer: Option (4) is right.
(8) The internal rate of return can best be described as:
Answer: The discount rate at which a set of cash flows have a zero net present value, therefore
option (1) is right.
(9) Which one of the following is true of the internal rate of return (IRR) approach to assessing
investments?
Answer: Use of IRR can be problematical when finance costs are changing from year to year.
Thus, the option (1) is correct.

(10) Of the followings two statements:
I According to the “separation theorem” , shareholders' wealth is not affected by the
financing method used by the business.
II According to the “separation theorem” , the business should be guided by the personal
consumption preferences of the shareholders when making investment decisions.
Answer: Statement 1 is true and statement 2 is false, therefore option (3) is right.
Question 4. Explanation of concepts and principles of value based management in relation to
shareholder value analysis (SVA) and economic value added (EVA).
Value based management (VBM) – This can be defined as a kind of approach which is
related with the process of increasing value of companies as well as maximisation of value of
shareholders (Firk, Schrapp and Wolff, 2016). Basically, it is beneficial for companies in order to
deal with deregulated capital markets as well due to this internal communication about strategy
enhanced effectively. This is based on some principles which are applied by users in an effective
manner for better results. Herein, below some principles of value based management are
demonstrated below that are as follows :
 Creating value – This is related with creation of futuristic value of shareholders. It is the
key principle of value based management because under this companies increase the
maximum possible futuristic value (Raithel and Schwaiger, 2015). In the aspect of
shareholders this is crucial because due to it value of shareholders in companies
operations increase. As well as they become able to get rights in business entities in
which they have shares.
 Managing for value – After the creation of value, next phase is to management of value
by effective communication and leadership. Apart from it, for better management of
shareholders value there are some other approaches such as change management,
governance and many more. In relation to shareholders value, this principle is very useful
because effective management of value of business entity is necessary.
 Measuring value- It is associated with the evaluation of value of shareholders in any
business entity (Blumenthal and Abrams, 2016). Basically, assessment of value of
business entity and shareholders is too crucial because on the basis of it corrective actions
are taken.
So these are they key principles of value based management.

REFERENCES
Books and journals :
Firk, S., Schrapp, S. and Wolff, M., 2016. Drivers of value creation—The role of value-based
management and underlying institutions. Management Accounting Research. 33. pp.42-
60.
Raithel, S. and Schwaiger, M., 2015. The effects of corporate reputation perceptions of the
general public on shareholder value. Strategic Management Journal. 36(6). pp.945-956.
Blumenthal, D. and Abrams, M. K., 2016. Tailoring complex care management for high-need,
high-cost patients. Jama. 316(16). pp.1657-1658.