Economic Value Added

By Ashutosh Bansal

EVA
A measure of a company's financial performance based on the residual wealth calculated by deducting cost of capital from its operating profit (adjusted for taxes on a cash basis). (Also referred to as "economic profit".) = Net Operating Profit After Taxes (NOPAT) - (Capital * Cost of Capital)
By Ashutosh Bansal

Return on Investment
Compare benefits (numerator) with resources (denominator) affecting that benefit
Basic earning power ratio
EBIT / Total assets

Return on assets
Net income / Total assets

Return on equity
Net income / Book value of equity
By Ashutosh Bansal

Measured relative to what?

Defining Quality
What is Quality? Right now:

Quality is low debt Reasonable Valuation Visibility in the Sector Good Management No blowups in the food chain STOCK HAS EARNINGS
By Ashutosh Bansal

Forecasting a Stock Price

Traditional Method
Discount Cash Flows back to Present Problem is that forecasting out 1 year is impossible, forecasting out further is mythology

Using Multiples
P = P/E * E (both are forecasts)

By Ashutosh Bansal

Weighted Avg. Cost of Capital

WACC = Weighted Average Cost of Capital WACC = %D * Rd (1 - taxrate) + %E * Re %D = % Debt % E = % Equity

%D + %E = 100% Rd = Cost of Debt Re = Cost of Equity = Rf + Beta * (Rm - Rf)

By Ashutosh Bansal

Calculating WACC
Too much time is spent in Finance curriculums on this issue. Use the marginal taxrate. For Rd use the companys market borrowing rates. Rf = use time horizon equal to your investment horizon. Stewart advocates 20 years. Between 5 & 10 years is sufficient.
By Ashutosh Bansal

My Thoughts on Beta
Q) What stock is < risky than the market? A) Very Few. Thus, Plug the Beta when you get a number like 0.9 or 1.0. Why? Imagine a one stock portfolio. You can always drastically reduce the risk by adding 5 or 10 stocks. In my opinion, a market-like Beta of 1.0 is not very realistic. Use Ibbotson risk premia (about 11%)
By Ashutosh Bansal

Why is WACC Important?

Imagine that your local bank will lend you $1 million at 10% interest. After getting the loan, you invest this in a stock that has an E(r) of 30%(not too far fetched in my opinion). Your projected cash flows in one year are:
Pay Receive the stock P/(L) $(1,100,000) million on the loan $ 1,300,000 from the sale of $
By Ashutosh Bansal

200,000

Profit

WACC is Capital Budgetings Benchmark Standard Capital Budgeting Rule

INVEST IN PROJECTS THAT EXCEED WACC INVEST IN POSITIVE NPV PROJECTS

Ask the CFO what the firms WACC is. You would be surprised how many CEOs and CFOs cant answer this question. This is a good hint that they dont understand the value creation process.
By Ashutosh Bansal

EVATM: Economic Value Added

EVA is trademarked by the Stern Stewart Corporation. They would like you to hire them as consultants. Two methods of calculating EVA: EVA = (ROIC - WACC) * Invested Capital EVA = NOPAT - WACC * Invested Capital ROIC = NOPAT / Invested Capital
By Ashutosh Bansal

EVA Terminology
NOPAT = Net Operating Profit After Taxes NOPAT = EBIT (1- T) NOPAT = NI + After tax Interest Expense
Note that depreciation is included because stern stewart believes that it represents a true economic expense. Whether or not this is true is your call. You could substitute maintenance CAPEX for depreciation.

By Ashutosh Bansal

Minority Interest Provision

Stern Stewart recommends: Adding the Minority Interest Provision from the income statement to Net Income and Adding the Minority Interest liability from the balance sheet to Capital I Disagree with this adjustment: Minority Interest represents the earnings which the firm IS NOT ENTITLED TO. Adding it back just skews ROIC higher or By Ashutosh Bansal lower (depends on ROIC of the subsidiary)

Why we Delever Returns

ROE is misleading
LEVERED METRIC TOUGH TO TELL WHETHER IT CHANGES DUE TO OPERATING OR FINANCIAL REASONS IF ROE IS GOAL, MGT. CAN ACCEPT LOUSY DEBT FINANCED PROJECTS AND/OR REJECT GOOD EQUITY FINANCED PROJECTS
By Ashutosh Bansal

Another Method of Calc NOPAT

NOPAT = Operating Income Less: Adjusted Taxes Tax Provision - Deferred Taxes + Interest Tax Shield - Taxes on Interest Income +Goodwill Amortization
By Ashutosh Bansal

Uses of EVA
Quantify Improving / Deteriorating Trends not yet reflected in EPS Forecast Target Price for a Stock Identify Value Drivers Use EVA to spot changes Identify what Divisions subsidize others Look at ROIC - WACC spread over time
By Ashutosh Bansal

Is EVA Unilaterally Useful?

Public Companies 1/3rd Add Value 1/3rd EVA Neutral 1/3rd Destroy Value Value Destroyers have embedded options that price improved future performance.
By Ashutosh Bansal

Importance of EVA Factors

1) ROIC - WACC % Spread : Most Import 2) Dollar EVA : Second Most Important. Why? Because there may not be many high value added projects. GM is a good example 3) Direction of ROIC - WACC Spread. Sometimes this is most important.
By Ashutosh Bansal

Case Study A study on Dabur Ltd with true figures during period (1998-2003)-

By Ashutosh Bansal

By Ashutosh Bansal

By Ashutosh Bansal

AssumingRisk free rate = 9% Risk coefficient= 0.71 Return of Market = 18.56%

By Ashutosh Bansal

By Ashutosh Bansal

By Ashutosh Bansal

By Ashutosh Bansal

By Ashutosh Bansal

By Ashutosh Bansal

By Ashutosh Bansal