Class25 Eva

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Alternative Valuation 1

Alternative Valuation Techniques

Economic Value Added (EVA)

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The Objective in Corporate

inance! "a#imi$e the value o% the %irm

! Three &a's to create value

*nvestment +ecisions

inancin, "i#

einvestment .olic'

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Alternative Valuation /

Classical +C Valuation

! The *nvestment +ecision invest in projects that

'ield a return ,reater than the minimum acceptable

ris0-adjusted hurdle rate (Accept positive .Vprojects)

! The inancin, +ecision Choose a %inancin, mi#

that minimi$es the cost o% capital

! The einvestment +ecision eturn cash to

shareholders i% 'ou do not have positive .V

projects

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Alternative Approach to

Valuation EVA! Economic Value Added (EVA) measures the

surplus value created b' an investment

EVA 4 (eturn on Capital *nvested - Cost o% Capital)

Capital *nvested

eturn on Capital *nvested 4 the 5true6 cash %lo&

return on capital earned on an investment

Cost o% Capital 4 the 7ACC

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9o& "uch Capital is *nvested:

! The mar0et value o% the %irm includes capital investedin both assets-in-place and %uture ,ro&th

! To calculate the invested capital add net %i#ed assets

plus net &or0in, capital as o% the be,innin, o% the 'ear

et &or0in, capital is calculated as Current Assets (not

includin, e#cess cash and mar0etable securities) less non-

interest bearin, current liabilities (omit notes pa'able; current

portion o% lon,-term debt)

! Alternativel'; 'ou can estimate the mar0et value o% theassets o&ned b' the %irm

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Alternative Valuation

7hat is the Cost o% Capital:

! The cost o% capital is the &ei,hted avera,e

cost o% capital

?se the mar0et values o% debt and equit' to

calculate the &ei,hts As is +C; man' %irms

use the boo0 value o% debt

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Alternative Valuation @

E#ampleEVABalance Sheet (in thousands)

Assets Year 0 Year 1 Year 2

Current Assets /B 38

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Alternative Valuation D

E#ample EVA

nco!e State!ent

Year 1 Year 2

Gales 18B;BBB 1>8;BBB

Operatin, costs DB;BBB 1BB;BBB

EI*T+ 8;BBB

+epreciation 18;BBB 18;BBB

EI*T 38;BBB

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Alternative Valuation 1B

E#ample EVA

! *nvested Capital

! A%ter-ta# operatin, pro%it

! eturn on Capital

Fr B Fr 1 Fr 2

>8;BBB @8;BBB @8;BBB

Fr B Fr 1 Fr 2

2>;BBB /

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E#ample EVA

! Economic Value Added %or 'ears 1 and 2

Fr B Fr 1 Fr 2

1D;8BB 2>;8BB

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EVA and .V! The .V o% a project 4 .V(EVA b' that project

over its li%e)

! *% there is a residual value associated &ith the

project; then

1 (1 )

nt

tt

EVANPVWACC=

=+

1

(1 )( )

(1 ) (1 )

nt

t nt

EVA t RV BVNPV

WACC WACC =

= +

+ +

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Alternative Valuation 1/

E#ample EVA and .VN"# with $# %&'000

Year 0 Year 1 Year 2

Gales evenue 18B;BBB 1>8;BBB

- Operatin, Costs (DB;BBB) (1BB;BBB)

- +epreciation (18;BBB) (18;BBB)

et Operatin, .ro%it (EI*T) 38;BBB ;BBB /;BBB /8;BBB) 1>;BBB 121;BBB

N"# * +A,, % 10- .0../&

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E#ample EVA and .V

Fr B Fr 1 Fr 2O.AT 2>;BBB /8;BBB @8;BBB @8;BBB

OC /;8BB

(V-IV) -

-Ta#es on V -

EVA & residual value 1D;8BB 2>;8BB

.VJ7ACC41BK 3B;38388

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E#ample EVA and .VN"# with $# % &120)000

Year 0 Year 1 Year 2

Gales evenue 18B;BBB 1>8;BBB

- Operatin, Costs (DB;BBB) (1BB;BBB)

- +epreciation (18;BBB) (18;BBB)

et Operatin, .ro%it (EI*T) 38;BBB ;BBB /;BBB /8;BBB) 1>;BBB 132;BBB

N"# * +A,, % 10- ()'0/2&

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Alternative Valuation 1;BBB /8;BBB @8;BBB @8;BBB

OC /;8BB

(V-IV) /8;BBB

-Ta#es on V (13;BBB)

EVA & residual value 1D;8BB 3@;8BB

.VJ7ACC41BK 8>;@BDD2

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Alternative Valuation 1>

Treatment o% esidual Value

2,2 3ethod E#A 3ethod

C &Oo residual EVA &Oo residual

LV L(difference betweenV and IV)-ta#es on V

(V-IV)Nt

-ta#es on V

(V-IV)Nt

4C &ith V 4EVA &ith V

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Alternative Valuation 1@

Continuation Value

! or an on,oin, concern; the continuation

value is calculated as a ,ro&in, perpetuit'

based on the %inal 'earPs cash %lo& There isno additional calculation %or ta#es

(1 )nn

FCF gCVWACC g

+=

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Alternative Valuation 1D

Continuation Value

! *n the C method; the entire continuation

value at time n is discounted bac0 to time B

! *n the EVA method; the continuation value

less the boo0 value at time n is discounted

bac0 to time B

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Alternative Valuation 2B

Gummar'

! Ioth EVA and +C valuation should provide

the same estimate %or the value o% a %irm

! Ioth approaches require the samein%ormation

! "a#imi$in, the present value o% EVA over

time should be equivalent to ma#imi$in, thevalue o% the %irm

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EVA *n ?se

! irms o%ten evaluate 'ear-to-'ear chan,es in EVA

rather than the present value o% EVA over time

! The advanta,e is that it is simple and does notrequire ma0in, %orecasts o% %uture earnin,s

potential

! EVA can be bro0en do&n b' an' unit - mana,er;

division; etc provided 'ou can assi,n capital andearnin,s across these units

! EVA is o%ten used in determinin, compensation

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Class25 Eva