Question

What is the best measure of shareholder value? Discuss a detailed description of each of the four measures (Economic profit, added value, cash value added, and economic value added). Also discuss the importance of free cash flows in determining stock valuations.

Answer 1

Economic value added would be the best measure of shareholders value because it is an estimate of economic profit above the shareholders expected rate of return.

Economic profit means the profit which have been added to the overall books of accounts by undertaking operations.

Added value concept means the difference of the selling price of the product minus the cost used to produce the product.

Cash value added means amount of cash flows which are added into the total value of the firm

While economic value added means estimate of economic profit which is above the shareholders expected rate of return.

Free cash flows is an inherent part of stock valuation as it is the overall learning ability of the form in the future which needs to be discounted at the present value to arrive at the valuation of the firm. Free cash flows gives an idea about total ability of the firm to generate cash flows in the long run so it is highly important.