Jeeves Software is a small software firm in high growth. The firm is all equity financed. In the current year, the firm earned $20 million in after-tax operating income on capital invested of $60 million. The firm’s cost of equity is 15%.
a. Assume that the firm will be able to grow its economic value added 15% a year for the next 5 years and that there will be no excess returns after year 5. Estimate the value of the firm. How much of this value comes from the EVA and how much from capital invested?
b. Now, assume the firm is able to reduce its capital invested this year by $20 million by selling its assets and leasing them back. Assuming operating income and cost of capital do not change as a result of the sale-lease back, estimate the value of the firm now. How much of the value of the firm now comes from EVA and how much from capital invested?
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