ABC&EVA

ECONOMIC VALUE
ADDED
Overview
 EVA
 MVA
 Value Based Management & Business Strategy
 Drivers of Shareholders Value
 Linking VBM to Business Strategy
 Keys to Success
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
•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
EVA is equal to after-tax operating profits of a firm less the cost of funds used to finance the investments.
frameworks for measuring corporate

finance
EVA is equal to after-tax operating profits of a firm less the cost of funds used to finance the investments.
• In other words a firm adds value for its

shareholders, if its return on capital
exceeds its cost of capital.
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 firm’s
operations, after tax but before financing
costs non-cash expenses.
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.
2. Calculate Net Operating Profit after Tax
(NOPAT).
3.
Calculate the company’s 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 company’s profit.
The positive result indicates that

organization is adding EVA for the
shareholders
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.
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.
Limitations
 Does not account for real options (growth

opportunities) inherent investment decisions, especially
in R & D, whereas a firm’s 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.
MARKET VALUE ADDED
An External Measure of how much better off the
shareholders as a consequence of management’s
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
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.
1. Growing concern about the diverse of ownership
from control
2. Adoption of VBM techniques by investment analysis
3. Emergence of aggressive shareholders
4. Problems assessing the impact of new management
techniques
5. Marketing efforts of management consultants
Areas covered by VBM
 Strategy Selection
 Resource Allocation
 Target Setting and Performance Measurement
 Managerial Reward Schemes
 Value Reduction
 Implementation
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.
The corporations overall value is
arrived by
Shareholders Value =
Business Value - Debt Value
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
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

 Investor understanding of firm’s
strategy
 Investor trust in ability of firm to
deliver its strategy
 Number of years over which
earnings are forecast
 Size of forecast earnings
 Length of time horizon of strategy
 Quality of strategic forecasts
 Past experience of firm’s ability to
implement strategy
 Extent of investor understanding of
strategy
 Achievement and publications of KPIs
 Quality of investor relations

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ECONOMIC VALUE

Popular measure being used by several

frameworks for measuring corporate

• In other words a firm adds value for its

The positive result indicates that

 Does not account for real options (growth

For firms with fewer assets is place and large growth

Business Value = Present Value of free cash flow

Market Expectations of future earnings

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