Konoberg is an engineering company, specialising in fluid dynamics. It is based in South Africa, but exports its expertise all over continental Africa and beyond. The company is soon to hold its annual management conference in Johannesburg, where the keynote theme is a discussion about the company's corporate financial objective. At present the company's financial objective is stated in terms of accounting profit, but the CFO is considering recommending changing this, to focus on creating shareholder value. The CFO of Konoberg is due to address the conference on the issue and has asked you, her executive assistant, to provide some input for the presentation. Konoberg currently has a sales turnover of R2,400 million and an operating profit of R288 million. This year's tax liability is R72 million and the operating profit has been calculated after allowing for an expenditure of R35 million on research and development. The company has long-term debt of R450 million and it also has an investment in a key supplier company that has been recently valued at R80 million. The balance sheet value of equity capital is R600 million. Although the current economic growth projections for the South African economy are quite low, the CFO believes that the recent devaluation in the value of the South African rand, particularly against the US dollar, will impact favourably on Konoberg and she is forecasting future sales growth to average around 14% per year, over the next 5 years, (the company's normal planning horizon). On the basis of past experience, it is estimated that the company will have to undertake additional investment in non-current assets, to support this growth in sales, at the rate of 8% of the value of increased sales. In addition, additional working capital investment will also be required at a rate of 5% of the additional sales. Konoberg has 10 million shares in issue on the Johannesburg stock exchange, where its current share price is R123. Overall, the company is expected to produce a 20% annual rate of return, given its risk.
Required:
(3500 words)
- Write a briefing paper for the CFO that outlines the main limitations of accounting profit as a financial objective metric and which discusses how an objective that focuses on shareholder value can overcome these limitations.
- Using Konoberg as a case study, undertake a shareholder value analysis, (SVA), of the company, explaining the need for any assumptions that you make in the analysis. Explain the connection between the corporate shareholder value objective and the SVA value.
- Critically discuss and contrast the concepts: economic profit and economic value added (EVA®).
- Calculate the EVA® of Konoberg and explain the relationship between this calculation and the company's SVA and how EVA® might be used as part of a management incentive scheme.
- Write a short memo to the CFO recommending, with reasons, the approach Konoberg should use to measuring shareholder value.