Question

7. The relationship between the book value of shareholders' equity and the firm's Market Value Added (MVA) and Economic Value Added (EVA) Yesterday, Water and Power Co. released its 2015 annual report on the company’s website. While reading the report for her boss, Asha came across several terms about which she was unsure. She leaned around the wall of her cubicle and asked her colleague, Rafael, for help. ASHA: Rafael, do you have a second to help me with my reading of Water & Power’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 Water & Power’s shares,” and then in another place, it uses “Market Value Added.” I’ve never encountered those terms before. Do you know what they’re talking about? RAFAEL: 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 ______ historical value or original purchase price market value or replacement cost , adjusted for any accumulated depreciation or amortization expense. The ________ net gross value, or difference between these two values, is called the asset’s book value.In contrast, when the term refers to the entire company, it means the total value of the company’s _______ shareholders’ equity total assets as reported in the firm’s _______ balance sheet income statement .ASHA: That makes sense. So, what makes this value important to investors is that it is ________ a historical an expected future value that can change—but only due to a couple of events, including the _________ repurchase sale of Treasury stock, the sale of new common or preferred shares, and the payment of _________ interest dividends . Equally important, it ________    will not will change in response to changes in the market prices of the firm’s shares. RAFAEL: Right! So, how useful would a firm’s book value be for assessing the performance of Water & Power’s management? ASHA: Well, because Water & Power’s book value _________ does not change changes with changes in the market price of the firm’s shares, the firm’s book value __________ cannot can reflect management’s efforts to maximize the price of the firm’s common stock and therefore ________ should not should be used to evaluate management’s performance. Now, what about “Market Value Added”? RAFAEL: During the 1990s, the consulting firm Stern, Stewart & Company developed the concept of Market Value Added, or MVA, to better assess management’s performance in maximizing their shareholders’ wealth. To achieve this, a firm’s MVA is computed as the _________ difference sum between (of) the _________ market book value and the ________    market book value of Water & Power’s shareholders’ equity. OK, now here’s a question for you: Compared to the book value, what is the advantage of the MVA as a means of evaluating management’s performance? ASHA: Well, I would say that because the market value of Water & Power’s shareholders’ equity is calculated by multiplying the shares’ ________ par value market price by the number of shares _________ outstanding authorized , then it will fluctuate depending on how the market perceives management’s performance. A positive assessment will result in ______    an increased a decreased market price and MVA. RAFAEL: Nicely done! Does this make your reading of Water & Power’s annual report easier?

Answer 1

The question is very specific in nature. Therefore, no explanation is possible.

______

The blanks are filled as below:

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 historical value or original purchase price, adjusted for any accumulated depreciation or amortization expense. The net value, or difference between these two values, is called the asset’s book value. In contrast, when the term refers to the entire company, it means the total value of the company’s shareholders' equity as reported in the firm’s balance sheet.

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 repurchase of Treasury stock, the sale of new common or preferred shares, and the payment of dividends. Equally important, it will not change in response to changes in the market prices of the firm’s shares.

______

Well, because Water & Power’s book value does not change with changes in the market price of the firm’s shares, the firm’s book value cannot 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.

______

During the 1990s, the consulting firm Stern, Stewart & Company developed the concept of Market Value Added, or MVA, to better assess management’s performance in maximizing their shareholders’ wealth. To achieve this, a firm’s MVA is computed as the difference between (of) the market value and the book value of Water & Power’s shareholders’ equity.

______

Well, I would say that because the market value of Water & Power’s shareholders’ equity is calculated by multiplying the shares’ market price by the number of shares outstanding, then it will fluctuate depending on how the market perceives management’s performance. A positive assessment will result in an increased market price and MVA.