1535 Words7 Pages

Chapter 13, ROIC and WACC
Lakehead University
Winter 2005
Role of the CFO
The Chief Financial Ofﬁcer (CFO) is involved in the following decisions: • Management Decisions
• Financing Decisions
• Investment Decisions
2
Performance Measurement
Here are some measures of performance a company can use:
• Earnings per share (EPS), growth in EPS
• Return on invested capital (ROIC)
• Return on equity
• Economic proﬁt (EP)
3
Performance Measurement
What is ROIC?
Pre-tax ROIC:
EBIT
Invested capital
After-tax ROIC:
(1 − t )EBIT
,
Invested capital
where invested capital is the sum of (the book values of) notes payable, long-term debt, preferred stock and common equity, and t is the company’s tax rate.
4
Performance Measurement
The ﬁrm’s economic proﬁt, on the other hand, is given by
EP = (ROIC − WACC) × Invested capital.
5
Weighted Average Cost of Capital (WACC)
What is the WACC?
Projects of levered ﬁrms are simultaneously ﬁnanced with both debt and equity.
The cost of a ﬁrm’s capital is a weighted average of the cost of debt and the cost of equity.
Since interest is a tax-deductible expense, we must use the after-tax cost of debt.
6
Weighted Average Cost of Capital (WACC)
The equation for a ﬁrm’s WACC is
WACC = wd × (1 − t )kd + w ps × k ps + we × ke , where d , ps and e stand for debt, preferred stock and common equity, respectively, wi stands for the weight of item i in the ﬁrm’s capital structure, i = d , ps, e, and ki stands for the cost (in
%) of item i.
7
Weighted Average Cost of Capital (WACC)
What weights must be used in WACC calculations?
How to calculate the cost of debt and the cost of equity?
8
Weighted Average Cost of Capital (WACC)
A ﬁrm’s balance sheet can be represented as follows:
Operating Assets
Invested Capital
Short-Term
Debt
NOWC
Long-term

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