Focused Finance

& EVA






Naina Adarsh
Tanvi Chaudhary
Pushpak Roy
Manishwar
Focused Finance
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EVA & Wealth Creation
Warren Buffet:
We feel noble intentions should be checked periodically
against results. We test the wisdom of retaining earnings by
assessing whether retention, over time, delivers shareholders
at least $1 of market value for each $1 retained.
Translation:
Ultimate test of any companys success lies in increasing
its market value by more than it increases its capital.
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View of the Firm
Value of firm = Value of Liabilities + Value of Equity
That is the amount of invested capital
Market value of a company reflects:
Earning power of invested assets
Present value of current operations
Present value of expected improvement in operating performance.

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Market Valued Balance Sheet
Assets Liabilities
Equity
What is Required to Focus?
Tie performance methods to capital budgeting
techniques:
Economic value added (EVA)
Market value added (MVA)
Want to gauge managements performance
Focus on:
Decisions made in the past to help project the future.
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Links to
NPV
Market Value Added
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Total
market
value
Debt &
equity
capital

Market
value added
Investment
In Company
Premium
What is EVA?
EVA = Economic profit
Not the same as accounting profit
Difference between revenues and costs
Costs include not only expenses but also cost of capital
Economic profit adjusts for distortions caused by
accounting methods
Doesnt have to follow GAAP
R&D, advertising, restructuring costs, ...
Cost of capital accounted for explicitly
Rate of return required by suppliers of a firms debt and equity capital
Represents minimum acceptable return.

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What is Cost of Capital
Evaluation of profitability should also consider the
lost opportunity that the capital has.
A company has Invested capital. This could make a
return elsewhere.
Before fully evaluating the profitability allowance
for the cost of this capital should be considered.
This represents an opportunity cost.
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Market Value Added
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Total
market
value
Debt &
equity
capital

Expected
improvement
in EVA
MVA
Current level
of EVA
MVA = Present value of all future EVA
Components of EVA
NOPAT
Net operating profit after tax
Operating capital
Net operating working capital, goodwill, and other
operating assets
Cost of capital
Weighted average cost of capital %
Capital charge
Cost of capital % * operating capital
Economic value added
NOPAT less the capital charge.
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Explicit Vs. Implicit Costs
Explicit costs are direct attributable costs like
materials or labour used in production.
Implicit costs or otherwise known as opportunity
costs are those costs that are the result of losing an
alternative use.
Example: If I have 1m to invest in a company, I
lose the opportunity to leave it in the bank earning
interest of say 5%.
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What is NOPAT?
Net sales 150,000
(-)Cost of sales 135,000
(-)Depreciation 2,000
(-)Selling &Admin exp 7,000
Net Operating profit 6,000
(-)Taxes @ 40% 2,400
NOPAT 3,600
Excludes financing charges
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What is Operating Capital?
Capital: Net operating assets adjusted for certain
accounting distortions
Asset write-downs, restructuring charges,
Net operating assets:
Cash, receivables, inventory, pre-paid expenses
Trade payable, accruals, deferred taxes
Net property, plant, and equipment
Exclude non-operating assets:
Marketable securities, investments,...
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What is Cost of Capital?
The cost of capital is the total % cost of debt and
equity that finances the business.
Weighted average cost of capital (WACC) consists
of:
Cost of debt after taxes
= Market interest rate x (1 tax rate)
Cost of equity
= Risk-free rate + beta x (market risk premium)
WACC
= Cost of debt after taxes x % debt +
cost of equity x % equity
where % debt + % equity = 100%.
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What is the Capital Charge?
Represents a rental charge for the use of the operating
capital
Minimum rate of return the operating capital should earn
Calculated as the firms weighted average cost of capital % x
invested capital.
It represents the opportunity cost of capital
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Calculating EVA
NOPAT/Average capital
= Return on invested operating capital (ROIC)
- Weight average cost of capital (WACC)
= Spread (= ROIC - WACC)
* Operating capital
= Economic value added (EVA)
Net operating profit after tax (NOPAT)
- Capital charge (= WACC * Capital)
= Economic value added (EVA)

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Whats Affecting
EVA?
Sales
- Operating expenses
- Taxes
= NOPAT
- Capital charge
= EVA
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COGS, SG&A + Other
Potential govt actions
Market potential
Forward Looking Relationship for
EVA & MVA
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EVA EVA EVA EVA
Year 1 Year 2 Year 3 .... Year n
Market
Value
Market
value
MVA
Capital
=
EVA + EVA + EVA + ... + EVA
1 + r (1 + r)
2
(1 + r)
3
(1 + r)
n
Market value is based on establishing the
economic 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
EVA Drives MVA
Companies that consistently earn profits in excess of
their required return ...
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NOPAT
EVA
Market
Value
Capital
MVA
Charge
are typically valued at premiums to book
value.
Manufacturing EVA Drivers
Reduce inventory
Reduce cycle time
Improve yields
Reduce scrap/waste
Maximize labor efficiencies
Improve vendor efficiencies
Process improvements
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Staff EVA Drivers
Work group/process simplification
Consistency monitors audit
Centralizing resources/synergies
Best practices benchmarking
Insourcing/outsourcing decisions
Simplify EVA measurements/reporting
Ensure compliance with legislation



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Marketing EVA Drivers

Increase market share / revenue
New markets
More focused channel programs
Voice of customer / consumer
Leverage advertising / promotion
Build brand awareness


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THANK YOU
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