MARKET VALUE OF INVESTED CAPITAL

EVA & Market Value. Market value of a company reflects: Value of invested capital. Value of ongoing operations. Present value of expected future economic profits. Captures improvement in operating performance. EVA related to market value by: Measuring all the capital. Seeing what the firm is going to do with the capital. Turn those free cash flow forecasts into EVA forecasts. Discount EVA to find market value added. FIN 591: Financial Fundamentals/Valuation.

The Invested Capital (IC) of a company is one measure of total firm value (like Enterprise Value). It represents the value of the core operations of the business. Alternatively, IC can also be defined as the combination of shareholder’s equity and interest-bearing debt. Whereas invested capital typically refers to the book value of invested capital, market value of invested capital is the invested capital amount at market value.

In accounting we learn: All Assets = All Liabilities & Obligations, which consist of all debts and all equities.

CA + FA + IA = CL +LTD + SE

Where:

CA = Current Assets
FA = Tangible Fixed Assets
IA = Aggregate Intangible Assets
CL = Current Liabilities
LTD = Long-Term Interest Bearing Debt
SE = Shareholders Equity

 

Subtraction of CL from both sides of this equation yields:

(CA – CL) + FA +IA = (LTD + SE)

The company’s MVIC can be thought of in two ways, each representing one side of the above equation.  The first explanation for MVIC is that it represents the value of the core business, including net working capital and all fixed and intangible assets. It is the value of the assets that keep the company operating and is represented by the left side of the above equation. The right side of the above equation represents the value of the monetary amount of capital invested in the company. It is the total claim to assets that all asset holders have in the firm.

Therefore:

MVIC = NWC + FA + IA, which is also equal to, LTD + SE

Practically speaking, if we were to calculate the MVIC of a public company at its market value, we would add the fair market value of the interest-bearing debt and the fair market value of the equity. In the fair market value valuation of a private firm or a public company we would calculate the MVIC by utilizing the Income, Transaction and Guideline Company Approaches and adding excess and non-operating assets.

Excess Assets

Typical invested capital numbers do not include excess assets including cash. Excess cash is defined as any level of cash held on a company’s balance sheet that is above what is necessary for core operations. This comes into importance when utilizing transaction multiples based on MVIC measures of firm value or comparing financial ratios using MVIC (such as ROIC) across firms in a given industry.

The problem associated with MVIC calculations lie in the the definition of excess cash. Some analysts or transaction databases include all cash when calculating MVIC, and some deduct an excess amount. Neither action is right or wrong, but it is necessary for the analyst to determine what data they are utilizing in their analysis for apples to apples comparisons.

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