MA3N0209 DEEGII
Introduction of EVA

EVA was developed by a New York consulting firm, Stern
Steward&Co.in 1983.

EVA is measurement tool of choice for making investment
decisions, measuring overall financial performance, and
motivating management.

Value-based measure the performance of a firm’s
management in creating value, capital projects and to
maximize long-term shareholders wealth.
Cont..

EVA represents “real” profits and provides a more accurate measure
than accounting profits.

Income calculations include only the cost of debt (interest expense)
whereas EVA uses the total cost of capital, both debt and equity.

Development outlays as investments in future products or processes
capitalizes rather than expenses them.

Over time, it also has better correlation with stock prices than does
earnings per share.

A growing EVA can signal future increases in stock prices.
EVA can be used for the following
purpose:

Determine management bonuses

Motivate management to achieve sales objectives & goals

Corporate valuation for shareholders, bankers & lenders

Performance measurement of Business

Capital budgeting & Investing decisions

Set organizational objectives & goals
Cons & pros EVA
Advantage


The advantages of EVA are it
disadvantage

EVA cannot measure how well
supplements financial data from
capital asset managers utilize
other methods of business
retained earnings via project
assessment and valuation.
management and other business
Another benefit of EVA is it can
ventures.
be used as a managerial incentive

EVA also cannot valuate return
that helps assure the continued
on expenses such as research and
performance of a business.
development.
EVA-basic calculation
EVA = Net Operating Profit After Tax - (Capital x WACC)



(NOPAT)-net operating profit after tax
capital
(WACC)-weighted average cost of capital
What is NOPAT?
NOPAT is profits derived from a company’s operations after cash
taxes but before financing costs and non-cash bookkeeping entries. It
is the total pool of profits available to provide a cash return to those
who provide capital to the firm.
Net Sales
Cost of Goods Sold
SG&A Expenses
Depreciation
Other Operating Expenses
Operating income
Tax (25%)
NOPAT
2,600.00
-1,400.00
-400.00
-150.00
-100.00
550.00
-140.00
410.00
What is WACC?
WACC is the avarage rate of return a company expects to compensate
all its different investors. The weight are the fraction of each financing
source in the company’s target capital structure.
WACC = ((E/V) * Cost of Equity) + [((D/V) * cost of Debt)*(1-Tax rate)]
E = Market value of the company's equity
D = Market value of the company's debt
V = Total Market Value of the company (E + D)
What is capital
Capital is the amount of cash invested in the 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.
Example
Assume that Company ABC has the

If a company has positive EVA,
following components to use the EVA
company ABC more than
formula:
covered its cost of capital.
NOPAT
= $4,480,000
Capital Investment = $2,400,000
WACC
= .067 or 6.70%

If a company has negative EVA,
project did not make enough
profit to cover the cost of doing
businesses
EVA = $4,480,000 - ($2,400,000 x
.067) = $4,319,200
Conclution

Companies that use EVA believe doing so leads to better
overall performance.

Managers who apply it focus on allocating assets, not just
accounting profits.

EVA helps enormously the management and employees to
see what should be real objective of the company, since it
makes clear to all what profitability really is
Why might a company use EVA as a measure of its performance in
addition to the standard accounting measures?
Many organisations use profit-based measures as the primary measure of their
financial performance. Two problems relating to profit in this area are:

Profit ignores the cost of equity capital. Companies only generate wealth
when they generate a return in excess of the return required by providers of
capital –both equity and debt. In financial statements, the calculation of
profit does take into account the cost of debt finance, but ignores the cost
of equity finance.

Profits calculated in accordance with accounting standards do not truly
reflect the wealth that has been created, and are subject to manipulation by
accountants.
EVA – is a performance measurement system that aims to overcome these two
weaknesses.
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