EVA and MVA

Primary goal of financial managers is to maximize the wealth of shareholders

MVA measures whether the above objective is achieved or not

MVA is the difference between the market value of the firm’s stock and the amount of equity capital the shareholders supplied

MVA

This difference is called the Market Value Added (MVA):

Lets stay, total number of shares outstanding of Luck cement are 300,000, its share price in market is Rs. 400, while its balance sheet showed that stockholders had put up only Rs.50 million. What was the MVA of Luck cement?

MVA

Economic Value Added (EVA)1 is an accounting-based measure of operating performance.

It measures the managerial effectiveness in a given year

• EVA = method of determining the extent to which a company earns profits in excess of its cost of capital

EVA = NOPAT – (WACC x NET ASSETS) Where NOPAT = Net operating profit after tax = EBIT (1 – T), Net assets= Adjusted book value of net capital at the

beginning of the period

Economic Value Added

It provides greater accountability for investor capital as it measures the required return on all investments.

It is easy to communicate. It aligns managerial and shareholders’

interests by tying management compensation to mprovements in EVA.

EVA has certain characteristics

NOPAT is calculated by deducting cash taxes from EBIT and adding the value of non-cash items like goodwill amortization and LIFO charges.

Depreciation is deducted to arrive at EBIT because depreciation is a real economic cost. To arrive at NOPAT:

Steps in EVA - Calculating Net Operating Profit After Tax (NOPAT)

.

Calculating NOPAT

.

Calculating Invested Capital

In the past, shareholders have been thought of as a free source of funds and management paid no attention to their well being

The biggest and most notable effect is that it has gotten managers and employees to think like shareholders as well as act like shareholders.

Increasing Eva always falls into one of the three following categories:

1. Rate of return increases with the existing capital base, meaning that more operating profits are generated without tying any more capital in the business.

2. Additional capital is invested in businesses earning more than the cost of capital. (Making NPV positive investments)

3. Capital is withdrawn or liquidated from businesses that fail to earn a return greater than the cost of capital.

How to Increase EVA

The primary goal of most firms is to maximize shareholders’ wealth

This goal also benefits the economy Shareholder wealth is maximized by

maximizing the difference between the market value of the firm’s stock and the amount of equity capital that was supplied by shareholders

Market Value Added (MVA)

This difference is called the Market Value Added (MVA):

To illustrate, consider Coca-Cola. In late 2001, its total market equity value was $123.5 billion, while its balance sheet showed that stockholders had put up only $10.4 billion. Thus, Coca-Cola’s MVA was $123.5 - $10.4 = $113.1 billion.

Market Value Added Value

Total market value

Book valuedebt +equity

Marketvalue added

Investment

Premium

Slide 16

Also, Market Value Added

Total market value

Bookvaluedebt +equity

Expectedimprovement in EVA

MVA

Current levelof EVA

MVA = Present value of all future EVA

Relationship for EVA & MVA

EVA EVA EVA EVAYear 1 Year 2 Year 3 .... Year n

MarketValueMarketvalue

MVA

Bookvaluecapital

=EVA + EVA + EVA + ... + EVA1 + r (1 + r)2 (1 + r)3 (1 + r)n

Market value is based on establishing theeconomic investment made in the company(capital), making a best guess about what economic profits (EVA) will happen in the future, and discounting those EVAs to the present to get market value added.

MVA

Companies that consistently earn profits in excess of their required return ...

EVA Drives MVA

NOPAT EVA

MarketValue

Capital

MVA

Charge

… are typically valued at premiums to book value.

Custo m er Satis faction N ew P ro ducts

Vo lum e M arketing

P roduct P ricing G row th

S a les

O verhead Co m pensation

Acco un t M anagem ent T ra ining & D evelo pm ent

M an ufactur in g Co sts

Operating E xpens es

Acqu isitions & D ivestitures W o rking Cap ita l M anagem ent

A lliances Acco unts R eceivab le

R & D D ecisio ns I nventory M anagem ent

C apita l C harge

Improvement in EVA

Slide 19

Manufacturing EVA DriversReduce inventoryReduce cycle time

Improve yieldsReduce scrap/waste

Maximize labor efficienciesImprove vendor efficiencies

Process improvements

Staff EVA DriversWork group/process simplification

Consistency “monitors” – auditCentralizing resources/synergies

Best practices benchmarkingInsourcing/outsourcing decisions

Simplify EVA measurements/reportingEnsure compliance with legislation

Manufacturing EVA DriversReduce inventoryReduce cycle time

Improve yieldsReduce scrap/waste

Maximize labor efficienciesImprove vendor efficiencies

Process improvements

Staff EVA DriversWork group/process simplification

Consistency “monitors” – auditCentralizing resources/synergies

Best practices benchmarkingInsourcing/outsourcing decisions

Simplify EVA measurements/reportingEnsure compliance with legislation

Research & Development EVA DriversImprove “to-market” process

Reduce R&D expenses as % of new product salesStrategic partners for R&D

Stronger links to product marketingNew products via:

- Research- Formulation

- Development- Acquisition

Marketing EVA DriversIncrease market share / revenue

New marketsMore focused channel programs

Voice of customer / consumerLeverage advertising / promotion

Build brand awareness

Research & Development EVA DriversImprove “to-market” process

Reduce R&D expenses as % of new product salesStrategic partners for R&D

Stronger links to product marketingNew products via:

- Research- Formulation

- Development- Acquisition

Marketing EVA DriversIncrease market share / revenue

New marketsMore focused channel programs

Voice of customer / consumerLeverage advertising / promotion

Build brand awareness