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EVA - Economic Value Added
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  1. 1. Economic Value Added (EVA) Presented by: NEEL BHAVIK AMIT VINIT
  2. 2. Introduction of EVA <ul><li>EVA was developed by a New York consulting firm, Stern Steward & Co. in 1982 to promote value-maximisig behaviour in corporate managers. </li></ul><ul><li>Value-based measure to evaluate business strategies, capital projects and to maximise long-term shareholders wealth. </li></ul><ul><li>EVA sets managerial performance target and links it to reward systems. </li></ul><ul><li>Unlike simple traditional budgeting. EVA focuses on ends and not means. </li></ul>
  3. 3. Definition for EVA <ul><li>EVA is defined as net profit after taxes and after the cost of capital. </li></ul><ul><li>FORMUALE for EVA </li></ul>EVA Net operating profit Taxes Cost of capital
  4. 4. Calculating Net Operating After Tax (NOPAT) <ul><li>NOPAT is easy to calculate. From the income statement we take the operating incomes and subtract taxes. </li></ul><ul><li>e.g. XYZ Company </li></ul>2,02,000/- NOPAT 1,34,000/- Taxes (-) 3,36,000/- Operating Profit 4,00,000/- Selling, general & Admin Exp. (-) 7,36,000/- Gross Profit 17,00,000/- Cost of Goods sold (-) 24,36,000/- Sales Amount (Rs.) Particulars
  5. 5. Cost of Capital <ul><li>Meaning: The cost of capital is the rate of return required by the shareholders and lenders to finance the operations of the business. </li></ul><ul><li>Types of Cost of Capital </li></ul><ul><li>Equity Capital: Equity Capital is provided by the Shareholders. </li></ul><ul><li>Borrowed Capital: It is the Capital borrowed by the company from Banks and other Financial Institutes. </li></ul>
  6. 6. Weighted Average Cost of Capital (WACC) <ul><li>Weighted Average Cost of Capital examines the various components of the Capital structure and applies the weighting factor of after-tax cost to determine the cost of Capital. </li></ul><ul><li>Calculating WACC </li></ul><ul><li>e.g. XYZ Company </li></ul>14,00,000/- Total Capital 7,00,000/- Total Common Equity 2,00,000/- Preferred Stockholders Equity 5,00,000/- Long Term Debt Amount (Rs.) Particulars
  7. 7. WACC Continue Long Term Debt <ul><li>Bond Cost </li></ul>9.47% Cost for Bond Financing (9/96 x 100) 9% Interest After Tax (Rs.14 – Rs. 5) 35% (Rs. 5/-) Assumed Tax 14% (Rs. 14/-) Interest Rs. 96/- Net Return ( Deducting discounting & Financing cost) Rs. 100/- Bond
  8. 8. WACC Continue Preferred Stock Cost 11.2% Cost for Preferred Share (11/98 x 100) 11% (Rs. 11/-) Dividend Rs. 98/- Net Revenue (Deducting discount & financing cost) Rs. 100/- Preference Share (Per share)
  9. 9. WACC Continue Common Equity Cost 14.1% Cost for Common Equity (12/85 x 100) Rs. 12/- EPS (Estimated by investors & reliable analyst) Rs. 85/- Net Return (Less issuing cost) Rs. 100/- Share Price (Per Share)
  10. 10. WACC Continue Summarizing 14.1% Common Equity Cost 11.2% Preferred Stock Cost 9.47% Bond Cost
  11. 11. Calculation of WACC for XYZ Company The total Weighted Average Cost of Capital (WACC) = 1,68,478 / 14,00,000 = 12.03% 1,68,475/- - 14,00,000/- Total Capital 98,700/- 14.1 7,00,000/- Common Equity Cost 22,400/- 11.2 2,00,000/- Preferred Stock Cost 47,375/- 9.47 5,00,000/- Long Term Debt Total (Rs.) Cost (%) Amount (Rs.) Particulars
  12. 12. Calculation of EVA for XYZ Company Rs. 21,550/- Economic Value Added (EVA) (Rs. 2,02,000 – Rs. 1,80,450) Rs. 1,80,450/- Capital Charge (12.03/100 x Rs. 15,00,000/-) 12.03% Cost of Capital Rs. 15,00,000/- Capital Employed (Including Rs.1,00,000/- Reserve & Surplus) Rs. 2,02,000/- NOPAT
  13. 13. Strategies for Increasing EVA <ul><li>Increase the return on existing projects (improve operating performance). </li></ul><ul><li>Invest in new projects that have a return greater than the cost of capital. </li></ul><ul><li>Use less capital to achieve the same return. </li></ul><ul><li>Reduce the cost of capital. </li></ul><ul><li>Liquidate capital or curtail further investment in sub-standard operations where inadequate returns are being earned. </li></ul>
  14. 14. Advantages of EVA <ul><li>EVA provides for better assessment of decisions that affect balance sheet and income statement or tradeoffs between each through the use of the capital charge against NOPAT. </li></ul><ul><li>EVA decouples bonus plans from budgetary targets. </li></ul><ul><li>EVA covers all aspects of the business cycle. </li></ul><ul><li>EVA aligns and speeds decision making, and enhances communication and teamwork. </li></ul>
  15. 15. Limitations of EVA <ul><li>EVA does not control for size differences across plants or divisions. </li></ul><ul><li>EVA is based on financial accounting methods that can be manipulated by managers . </li></ul><ul><li>EVA may focus on immediate results which diminishes innovation. </li></ul><ul><li>EVA provides information that is obvious but offers no solutions in much the same way as historical financial statement do. </li></ul>
  16. 16. Conclusion As a performance measure, Economic Value Added forces the organization to make the creation of shareholder value the number one priority. EVA is changing the way managers run their businesses. When business decisions are aligned with the interest of the shareholders, it is only a matter of time before these efforts are reflected in a higher stock price.
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