Economic Value Added

Presented By:
Swapnil Gattewar (Roll No. 72) Chaitanya Gandhi (Roll No. 68) Rhea Baliwala (Roll No. 67) Yugesh Gobji (Roll No.75 ) Dhwani Shah (Roll No. 71) Pritesh Chaudhary (Roll No. 69 ) Anil Gawade (Roll No. 74) Aniket Deshmukh (Roll No. 70 )
Cost & Management Accounting

Introduction
A Performance Measurement Tool

Managerial

Economic

Managerial Performance

Efficiency

Effectiveness

Economic Measure

Capital Cost
Cost & Management Accounting

Shareholders Value
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Interpreting the EVA

A positive EVA means the firm generated a return to invested capital that exceeds the opportunity cost of capital The Company Value increases

A negative EVA means the firm did not generate sufficient return to cover its cost of capital The Company Value declines

The trend in EVA is more important than the absolute value of EVA

Cost & Management Accounting

Formulation & Components

NOPAT

EVA
WACC
Concept developed by Stern Stewart & Co.
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Cost & Management Accounting

Formulation & Components

EBIT

Start with accounting

EBIT

Adjustments

Purpose is to bring it closer to a Cash Profit

Tax

Reduce actual tax payment

Cost & Management Accounting

Formulation & Components

Recommendation by Stern Stewart & Co for making adjustments for NOPAT

The amounts are significant Managers can influence the outcome of the item being

adjusted
The required information is readily available Non-finance professionals can understand them. (Stewart 1991)

Stern Stewarts have suggested close to 160 adjustments!!

Cost & Management Accounting

Formulation & Components

Net Assets / Capital Employed

Weighted Average Cost of Capital (WACC)

Post Tax Cost of Capital

Cost & Management Accounting

How to increase EVA?

Try to improve returns with no or with only minimal capital investments Produce the same goods and services using less capital

Invest new capital only in projects, equipment, machines able to cover capital cost while avoiding investments with low returns
Reduce the cost of capital

Cost & Management Accounting

Performance Vs Wealth Metric

Performance Metric: A measure under the companys control Wealth Metric: A measure of value that depends on the stock markets forward looking view
Cost & Management Accounting

EVA Vs Other Performance Measures

Income statement variables: operating profit, earnings, net income
The investors are interested in what kind of resources (what amount of capital) are required to produce certain profit figure. A profit figure alone without capital base is irrelevant

ROI, RONA, ROCE etc. (Return on invested capital)

All accounting rates of return fail to steer the company correctly i.e. rate of return should not be maximized

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EVA Vs Other Performance Measures

For example: Consider a SBU producing ROI of 60%. The SBU faces an investment opportunity producing a return of 30%. Should the SBU undertake the project? How does the project influence the ROI of the SBU? Capital costs into income statement:
When the costs of capital are shown in income statement operating people are able to see the importance of capital from the viewpoint of profitability. After realizing the true costs of capital operating people are often able to decrease excess employed capital considerable EVA is much more easy concept of profitability than ROI and furthermore it can be translated into day-to-day operations

Cost & Management Accounting

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Advantages of EVA approach

Indicates Companys Worth Better and True Picture of a Company Decision Making Easier to Sell and Buy Stocks Improves Corporate Better Investment Opportunities Monitors Problem

Governance
Includes the Cost of Equity

Areas
Eliminates the

fallacy of Accounting
Profit
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Cost & Management Accounting

Limitations of EVA approach

EVA does not control for size differences across plants or divisions

Low Capital Base will generate a large Positive EVA irrespective of the Cash Flows

EVA may focus on immediate results which diminishes innovation EVA provides information that is obvious but offers no solutions in much the same way as historical financial statements do Difficulty is in finding correct cost of equity
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The 3 Simple Ideas

1. Cash is King i.e. Cash Flows are the best indicators of a companys performance

2. Some expenses are really Investments in disguise and should be capitalized on the Balance Sheet 3. Equity Capital is expensive (or at the very least, not free). This expense therefore must be accounted for

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 EVA Video

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Takeaways
Earnings Opportunity Cost of Capital
30000 actual -20000 expected 10000 EVA

Investors - Performance v/s other potential investments

Preferred over EPS Warren Buffet

Company - evaluating
Most economically valuable project Performance of managers

Investments in capital intensive sector - Effective in ensuring that you are targeting smartest investment
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References
Foundations of Economic Value Added J L Grant Research Paper on Economic Value Added - A General Perspective Asish K Bhattacharyya & B.V.Phani Value Based Management by Sirbu Alexei Value based management. Control processes to create value through integration; Vlerick Keuven Gent Management School; 2008 by Ameels, Anne A Paper on Introduction to Economic Value Added by Esa Mkelinen Investopedia - The Investor's Encyclopaedia www.sternstewart.com www.valuebasedmanagement.net www.accaglobal.com www.evanomics.com pages.stern.nyu.edu

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THANK YOU

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