Capital Structure of CVS - Assignment Example

There are various ways of measuring a firm's performance. One way is to use accounting measures such as return on equity, return on assets, etc. Another way is to use market measures and determine the firm's performance by looking at the stock's value. These measures, however, do not provide an effective evaluation of firm performance. One such measure that determines the true value-creating performance of a firm is Economic Value Added (EVA) analysis. This analysis attempts to determine the net contribution to value by a company's investment decisions which other measures fail to provide.

This means the after-tax returns of the company should exceed the cost of capital invested. EVA is calculated as follows: EVA = (ROIC - WACC) x Invested Capital The formula for Return on Invested Capital (ROIC): ROIC = Net Income / Liabilities + Shareholders Equity ROIC for CVS = 11.4% Invested Capital = market capitalization = 262,500,000 (common stock * share price) EVA for CVS is: 7,875,000 EVA is dependent on return on invested capital as well as the cost of capital. Higher ROIC and a lower cost of capital can increase EVA significantly.

An EVA of 7,875,000 means this is the net contribution to value added by the company's investment decisions. Higher EVA can alter the capital structure by increasing the proportion of equity to debt. However, every company has a target in terms of maintaining. The weighted average cost of capital is the discount rate used to convert expected future cash flow into present value for all investors. Using the book value of debt and equity, CVS is 26.2% financed by debt and 73.8% financed by equity.

Cost of equity can be calculated using the capital asset pricing model.