Economic Value Added Analysis of Microsoft Corporation Report

This report presents an Economic Value Added (EVA) analysis of Microsoft Corporation, evaluating its overall financial performance and potential value if its segments were independently assessed. The analysis identifies three key segments: Intelligent Cloud, Productivity and Business Processes, and More Personal Computing. Financial statement analysis, ratio analysis, and trend analysis are employed alongside EVA to provide a comprehensive valuation. The report details the strategic advantages of potentially breaking up the company, though acknowledges the limitations of EVA for technology-based organizations. The EVA calculation, utilizing NOPAT, invested capital, and WACC, is thoroughly explained. The report concludes by highlighting how EVA can inform investment and managerial decisions, reflecting on the company's ability to generate returns above its cost of capital.

Running head: VALUE ANALYSIS USING EVA (MICROSOFT CORPORATION) 1
Value Analysis Using EVA (Microsoft Corporation)
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Executive Summary
This paper gives a report on an analysis and evaluation of Microsoft Corporation using
Economic Value Added (EVA), which is the primary tool of analysis used in this paper. It is
believed that a true and fair value of a company is determined by its ability of generating cash
returns that exceed the cost of capital (Rakshit, 2012). The objective of this project is to identify
a company that might be worth much more if it were broken into pieces and then valued
separately using Economic Value Added (EVA). In this paper, Microsoft Corporation has been
selected based on its strategic advantage and financial analysis as well. An Economic Value
Added (EVA) analysis of the combined company as well as its individual elements or parts (that
would be valued much higher if they were separate) has been given in this paper. In addition to
this, the paper explains the strategic advantages that could possibly be attained from a break up
that are not rationalized by Economic Value Added (EVA) analysis only.
However, there are other methods of analysis used including financial statement analysis,
ratio analysis and trend analysis over the past years of operation of the company. All calculations
and workings are clearly shown. According to the results of Economic Value Added (EVA)
analysis, the company (Microsoft Corporation) has three main segments which can be valued
separately. These are Intelligent Cloud segment, Productivity and Businesses Processes as well
as More Personal Computing segment (Emery, Finnerty & Stowe, 2007). Each of these segments
have been further discussed in the below sections of this paper. However, this analysis has some
limitations. The Economic Value Added (EVA) analysis is suitable for those manufacturing
companies that are asset intensive and may not be appropriate for technology based
organizations (Arnold, 2013).

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Introduction
Microsoft Corporation has its head offices in Redmond, Washington. It is the leading
American multinational company that develops personal computer software systems as well as
applications. It also takes part in publishing books. It produces its own tablet computers, offers
emailing services and designs electronic game systems. It also manufactures computer
peripherals including input and output devices. It has outlets and supply stores in various places
all over the world (Microsoft, 2001).
It was founded by Bill Gates and Paul G. Allen, who were two friends since their
childhood. They started by converting BASIC, a popular language in computer programing, into
a better mode that was suitable for use in the early personal computers commonly known as the
Altair (Emery, Finnerty & Stowe, 2007). Later on, the two founded Microsoft Corporation,
whose name was derived from the words “microcomputer” and “software”. They afterwards
defined BASIC and created various other programming languages (Microsoft Corporation,
2009).
The International Business Machines (IBM) Corporation requested Microsoft
Corporation to design an operating system for its first personal computer in the year 1980.
Instead, Microsoft bought an operating system from another company and modified it to
Microsoft Disk Operating System (MS-DOS). After releasing this software, most companies that
manufactured personal computers were able to license MS-DOS as their operating system. This
generated a lot of revenue to Microsoft Corporation (Pohlman & Gardiner, 2000).
In the 1990s, Microsoft Corporation became the most powerful and popular company in
the history of America. It had become a publicly owned corporation in the year 1986. It was

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consistently making profits of twenty five percent on each sales dollar. This was really an
amazing record. During its 1956 financial year, the company its net income was topped by two
billion dollars for the first time, and its profits continued to grow during the great economic
recession (Arnold, 2013).
Analysis of Microsoft’s Shares and Stocks
Microsoft’s explosive and rapid growth in its cloud has attracted most investors to
venture in its stocks. It competes mainly with Amazon, which is categorized as retail, and does
not appear in the technology stock screen. However, Microsoft has the most popularity among
investment firms, having been positioned in the second place while Amazon being in the fifth.
Microsoft expects to expand and grow its cloud market by forty percent annually. It has tripled
its market share to that of Amazon, having grown to three percent unlike Amazon which has
only one percent (Microsoft Corporation, 2009).
The performance of Microsoft Corporation in Azure has boosted its annual revenue by
twelve percent yearly to twenty four billion dollars. Its net income increased by sixteen percent
to six billion dollars. It has used four billion dollars in repurchasing shares and dividends, thus
increasing its dividends by eight percent to forty two cents a share. The largest investor guru is
the founder of the company, Bill Gates, with outstanding shares of 0.73%. He is followed by
Dodge and Cox, with 0.52% of Microsoft’s shareholdings, and then followed by the management
of First Eagle Investment with 0.34% shares (Trotta, 2003).
The intelligent cloud segment has realized an income of approximately seven billion
dollars, which was reported as a percentage increase of fifteen. The more personal computing
segment earned a revenue of twelve billion dollars, up two percent. This gave a total revenue of

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twenty nine billion dollars, which was a twelve percent annual increase. This raised the gross
margin of the company to sixty two percent, and its net operating revenue hit eight billion dollars
having increased by ten percent (Atkinson, 2016).
Individual Segments or Elements in Microsoft Corporation
Microsoft Corporation was founded as a technology based company that develops
supports and licenses a variety of devices, software and products. The company has three main
segments or elements including More Personal Computing, Productivity and Business Processes
and Intelligent Cloud. Its main products are operating systems, server applications, server
management tools and cross-device productivity applications among others (Microsoft, 2001).
The main devices that it manufactures include the gaming and entertainments tools,
personal computers, phones and tablets. In addition, it offers a wide range of services which
include cloud-based solutions, consulting services and online advertising that reaches global
audience. Each of the above product, service or device falls in one of the segments which are
further explained below (Microsoft Corporation, 2009).
a. Intelligent Cloud
The intelligent cloud segment of this company mainly consists of its private and public
services as well as hybrid server products including cloud services. It’s primarily comprised of
cloud services and server devices (Emery, Finnerty & Stowe, 2007). These comprise of the
servers in window, SQL, system center, Azure, related Client Access Licenses (CALs),
enterprise services as well as visual studio. The enterprise services include Microsoft consulting
and premier support services. The server products are meant to increase the efficiency of the

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information technology professionals and enhance productivity of their systems (Microsoft,
2001).
The server software integrates infrastructure and middleware and is designed for
supporting the operating systems applications in the windows servers. The intelligent cloud is
also involved in licensing the standalone and tools for software development lifecycle, which are
used by project managers and developers. Azure is an advanced cloud computing platform that
has networking, database and storage services. It helps customers and organizations devote
resources into developing and using applications, instead of managing the on-premises hardware
or software (Microsoft Corporation, 2009).
b. Productivity and Businesses Processes
This is a segment consisting mainly of services and products in the range of the
company’s performance, information services and platforms. Its main elements are the office
commercial, which includes subscriptions and volume licensing for products and services such
as SharePoint, skype, exchange and related Client Access Licenses (CALs). Office commercial
helps manage organizational, personal or team productivity via a variety of products and
services. Skype is a service that is designed for connecting families, friends and people through
devices (Microsoft, 2001).
c. More Personal Computing
This segment of Microsoft Corporation comprises products and services that are aimed at
meeting the interests of various end users and developers. It mainly includes windows, mainly
covering the windows OEM licensing (Emery, Finnerty & Stowe, 2007). Various devices such as
Microsoft surface, personal computer accessories, gaming devices and phones are part of more

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personal Computing. These devices enable people to connect to other people and acquire content
via windows and integrated services of Microsoft. Surface helps consumers, students and
organizations to enhance their productivity (Microsoft Corporation, 2009).
Economic Value Added (EVA) Analysis of Microsoft Corporation
According to Rakshit (2012), Economic Value Added (EVA) is an analysis method that
compares net operating profit of an investment to its total capital cost or charge. It measures
financial performance of a company based on remaining returns after deducting the cost of
capital from operating profits after making adjustments for income taxes on the basis of cash.
Also termed as the economic profit, this method of analysis reveals the true and fair economic
profit of a company (Trotta, 2003).
It gives the additional difference in the rate of return rate over the capital cost of the
company. It also gives the value that the business generates from funds that have been invested
into it. The analysis helps mainly in measuring the value that is generated by a company from the
funds that are shareholders invest into it. It helps in reviewing and seeing the areas of a business
that can be highly adjusted to improve the general productivity of the organization
(Rakshit, 2012).
The results of Economic value Addition have different indications on decisions that
should be made (Schaefer, 2002). For instance, if the Economic Value Added (EVA) of a
company is negative, it implies that the company does not generate sufficient value from the
funds invested. This implies that the company is value on the funds invested. A business whose
Economic value Added remains negative should be shut down. However, if it is positive, it

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shows that the company is making value out of the funds invested in its business (Atkinson,
2016).
Economic Value Added (EVA) helps investors and management to assess the
performance of Microsoft Corporation by considering the wealth and returns created for the
shareholders, therefore raising performance above its cost of capital (Schaefer, 2002). Economic
Value added (EVA) is a key indicator of financial performance, since it shows how well the
company has utilized the assets to generate income. This helps the company management in
making viable investment and managerial decisions (Rakshit, 2012).
By reflecting on performance of the company management, Economic Value Added
(EVA) indicates how projects of the company are (Issham, 2011). This analysis tool asserts that
companies ought to generate returns and profits at a rate higher than the cost of capital. It has
many advantages including giving a summary of how much wealth was generated and from
which sources. Its inclusion of balance sheet items in calculation ensures that managers consider
all assets and expenses in decision making (Atkinson, 2016).
Economic Value Added (EVA) for the Combined Company
Economic Value Added (EVA) is arrived at using the calculation below:
EVA = NOPAT – (Invested Capital * WACC) where NOPAT is the Net Operating Profit
after Tax (Rakshit, 2012).
There are three components for arriving at the EVA, that is, Net Operating Profit after
Tax (NOPAT), the Weighted Average Cost of Capital (WACC) and the capital invested. These
can easily be calculated and can be obtained from the income statement of Microsoft Corporation

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(Issham, 2011). The invested capital is the amount of cash used in funding a given project. The
WACC multiplied by the amount of invested capital arrives at the finance charge, which is the
amount needed by investors as a group to make their investment worthwhile (Atkinson, 2016).
Invested capital = Total assets – Current Liabilities
Economic Value Added (EVA) aims at quantifying the cost or charge of making capital
investment into a particular project or company, and then assessing if it creates adequate returns
for making it a viable investment (Rakshit, 2012).
NOPAT calculation for Microsoft Corporation (in million Dollars):
The year ending Fiscal year 2017 Fiscal year 2016
Net operating income $21,205 $16,797
Deferred income tax expense (benefit) -3,296 332
(Decrease) increase in allowance for doubtful accounts -21 91
Unearned revenue (Decrease) increase 10,570 8,591
Restructuring liability (Decrease) increase -277 -128
Equity equivalents (Decrease) increase 6,976 8,886
Interest expense 2,222 1,243
Lease obligations (Interest expense) 237 170
Interest expense (Adjusted) 2,459 1,413

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Interest expense (Tax benefit) -861 -495
After taxes interest expense 1,599 919
Marketable securities loss (Gain) -2,583 -668
Dividends and interest income -1,387 -903
Before taxes, investment income -3,970 -1,571
Investment income from tax expense or income 1,390 550
After taxes, investment income -2,581 -1,021
Operating profit after taxes-Net (NOPAT) 27,198 25,581
Microsoft Corp., invested capital calculation (in million Dollars):
Fiscal year 2017 Fiscal year 2016
Current Debt $9,072 $12,904
Long-term debt (Current portion) $1,049 –
Long-term debt (less current portion) $76,073 $40,783
Present Value of operating lease payments 6,980 5816
Debt & leases 93,174 59,503
Stockholders' equity 72,394 71,997
(Assets) liabilities Net deferred tax -1,883 1,256

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Provision for doubtful debts 405 426
Unearned income 44,479 33,909
Restructuring liability 432 709
Equity equivalents 43,435 36,301
Accumulated other comprehensive (income) loss -431 -1,537
Adjusted stockholders' equity 115,398 106,761
Investments -131,341 -117,161
Invested capital 77,231 49,103
The Weighted Average Cost of Capital (WACC) = 10.99%. Therefore, the Economic
Added Value (EVA) for the combined company is calculated as:
EVA = $27,198 – ($77,231 * 10.99%)
= $18,710.31
This is a positive figure, implying that the company is making good returns out of the
capital invested in its business (Rakshit, 2012).
Economic Value Added (EVA) for the Segments/Elements Valued Separately
The Net Operating Profit after Tax (NOPAT) from those three major segments was as
follows for the financial years 2017 and 2016 (Pohlman & Gardiner, 2000).
2017 2016

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Productivity and business processes $11,913 $12,418
Intelligent cloud $9,138 $9,315
More personal computing $8,288 $6,202
Total 22,326 20,182
EVA for Productivity and business processes = 11,913 – (77,231 * 10.99) = $3,425.31
EVA for Intelligent cloud = 9,138 – (77,231 * 10.99) = $650.31
EVA for more personal computing = 8,288 – (77,231 * 10.99) = ($199.69)
The two segments, intelligent cloud and Productivity and business processes, both
have a positive figure for Economic Value Added Analysis. This is an indication that they have a
good return on the capital invested in the projects. However, the segment for more personal
computing has a negative EVA, meaning that its returns are not as good as the amount of capital
invested. The invested capitals’ return rate is lower than the capital cost (Rakshit, 2012).
On analyzing and evaluating Microsoft Corporation using Economic Value Added
analysis, it has been found that the business requires huge amounts of capital. Significant
proportion of this capital is covered by the cash flows from the more personal computing
segment, thus giving it a low EVA (Issham, 2011). The other two segments of the corporation
are the Intelligent cloud and Productivity and business processes. These need modest amount of
capital and are able to generate amounts of cash flows, thus giving them a high valuation based
on the analysis of the Economic Value added (Microsoft Corporation, 2009).