ECONOMIC VALUE ADDED

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ECONOMIC VALUE ADDED

• WELCOME

• P.RAJU IYER

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Overview

• EVA
• MVA
• Value Based Management Business Strategy
• Drivers of Shareholders Value
• Linking VBM to Business Strategy
• Keys to Success

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EVA focuses on Economic Income the income
generated by the company net of the
investors required return on capital invested
Popular measure being used by several firms to
determine whether an existing proposed
investments positively contributes to the Owners
/ Shareholders wealth
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• EVA is equal to after-tax operating profits of a
  firm less the cost of funds used to finance the
  investments.
• Combines the accounting and finance frameworks
  for measuring corporate finance
• In other words a firm adds value for its
  shareholders, if its return on capital exceeds
  its cost of capital.

EVA is equal to after-tax operating profits of a
firm less the cost of funds used to finance the
investments.
EVA is equal to after-tax operating profits of a
firm less the cost of funds used to finance the
investments.
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EVA

• Capital is the amount of cash invested in
  business, net of depreciation. It can be
  calculated as the sum of interest-bearing debt
  and equity or as the sum of net assets less
  non-interest bearing current liabilities.
• NOPAT is profits, derived from the firms
  operations, after tax but before financing costs
  non-cash expenses.

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To determine the EVA adjustments has to be
effected on the published accounts from the
investors point of view traditional calculation
of the return on capital is distorted due to
accounting conventions 1. Calculate the adjusted
capital employed Equity and Debt adjustment
for items such as cumulative good will associated
with acquisition - adjust for amounts charged to
Reserves unless the underlying economic value has
reduced, R D expenditure to be treated as
capital investment as they will produce revenues
in future.
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• 2.   Calculate Net Operating Profit after Tax
  (NOPAT).
• 3.     Calculate the companys Weighted Average
  Cost of Capital (WACC).
• 4.     Multiply the cost of capital by the
  capital employed to produce a capital charge
  which is then deducted from the companys profit.
  
• The positive result indicates that organization
  is adding EVA for the shareholders

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This approach is attractive where substantial
assets are tied up in projects,because it
simplifies the process of value creation to one
or more of a few actions.
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1. Increasing the operating income from assets in
   place by reducing costs or increasing sales.
2. Reducing the cost of capital by changing the
   financing mix.
3. Reducing the amount of capital tied up in
   existing projects, without affecting operating
   operating income significantly, by reducing
   working capital investment and selling unutilized
   or underutilized assets.

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Limitations

• Does not account for real options (growth
  opportunities) inherent investment decisions,
  especially in R D, whereas a firms market
  value does take this into account. Therefore,
  growth in EVA becomes more relevant.
• For firms with fewer assets is place and large
  growth opportunities, EVA is not likely to
  explain the changes in market prices.

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MARKET VALUE ADDED
An External Measure of how much better off the
shareholders as a consequence of managements
performance. MVA seeks to reflect the decisions
of the present management team or the period of a
major business decision such as an acquisition
takes place. MVA Rise in Market Capitalization
during the period - Increase in capital invested
during the period
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VALUE BASED MANAGEMENT

• A Methodology that involves managing all aspects
  of the business in accordance with the desire to
  create and maximize the wealth of shareholders.
• Growing concern about the diverse of ownership
  from control
• Adoption of VBM techniques by investment analysis
• Emergence of aggressive shareholders
• Problems assessing the impact of new management
  techniques
• Marketing efforts of management consultants

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Areas covered by VBM

• Strategy Selection
• Resource Allocation
• Target Setting and Performance Measurement
• Managerial Reward Schemes
• Value Reduction
• Implementation

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DRIVERS OF SHAREHOLDERS VALUE
Business Value Present Value of free cash
flow from operations plus value of marketable
securities The amount of cash it is generating
which could potentially become dividend and will
be the basis of the market capitalization of the
business. The securities or investment held by
the company which could be disposed of for cash
without affecting operations.
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The corporations overall value is arrived by
Shareholders Value Business
Value - Debt Value
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To Increase shareholder value, the Management
should increase Business Value or reduce Debt.

• Sale Growth Rate
• Operating Profit Margin
• Cash income tax rate
• Incremental fixed capital investment rate
• Investment in working capital rate
• Planning Period
• Cost of Capital

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LINKING VBM TO BUSINESS STRATEGY
EVA ignores future forecast earnings. Other
approaches to VBM take future earnings into
consideration on the grounds that the perceptions
investors hold of future earnings will influence
the share price and hence MVA. Market
Expectations of future earnings
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• Investor understanding of firms strategy
• Investor trust in ability of firm to deliver
  its strategy
• Number of years over which earnings are
  forecast
• Size of forecast earnings

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• Length of time horizon of strategy
• Quality of strategic forecasts
• Past experience of firms ability to
  implement strategy
• Extent of investor understanding of strategy
• Achievement and publications of KPIs
• Quality of investor relations

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• THANK YOU

• THANK YOU

• THANK YOU