EVA & Market Value

Market value of a company reflects:

Value of invested capital Value of ongoing operations Present value of expected future economic profits

Captures improvement in operating performance

EVA related to market value by:

Measuring all the capital Seeing what the firm is going to do with the capital Turn FCF forecasts into EVA forecasts Discount EVA.
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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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Components of EVA
NOPLAT

Net operating profit after tax

Net operating working capital, net PP&E, goodwill, and other operating assets Weighted average cost of capital % Cost of capital % * operating capital NOPLAT less the capital charge.

Operating capital Cost of capital

Capital charge Economic value added

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What is NOPAT?
Net sales Cost of sales Depreciation SG&A Net Operating profit Taxes @ 40% NOPAT 150,000 135,000 2,000 7,000 6,000 2,400

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, Cash, receivables, inventory, prepaids Trade payable, accruals, deferred taxes Net property, plant, and equipment

Net operating assets:

Exclude non-operating assets:

Marketable securities, investments,...

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What is Cost of Capital?

Weighted average cost of capital 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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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
Market potential

COGS, SG&A + other

Potential govt actions

- Capital charge
= EVA

Net working capital PP&E WACC

Evaluate the many assumptions!

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Fundamental Strategies
NOPAT EVA Cost of capital * Capital Capital
Operate: Improve the return on existing operating capital Decrease: WACC Build: Invest as long as returns exceed the cost of capital Harvest: Re-deploy capital when returns fail to achieve the cost of capital.
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An Example of Drivers

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Focus on EVA Improvement

A positive change in EVA is better than a positive yet

unchanging base level of EVA

Why?

Positive changes in EVA are consistent with shareholder value added -- whether from a positive or negative base Positive changes in EVA are consistent with the managerial notion of continuous improvement in performance.

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Heres the Point

EVA is the reward from investing in projects

that return above the cost of capital

EVA = (ROIC - WACC) * Operating Capital

Each projects expected return must exceed its

cost of capital to be justified.

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Value added conceptual framework

Meaning and Definition

A manufacturing firm begins with a certain quantum of raw materials, and then engages itself in a conversion process to yield a product with new utility and market value which is different from the original cost of materials. The excess of such market value over the cost of materials is defined as value added.

The term value added may be simply defined in Economics as the difference between the value of output produced by a firm in a period. Value added= Value of output-Value of inputs
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Value added is the value in which entity has added in a period which equals its sales less bought-in goods and services. Value added=Sales-Bought-in- goods and services Value added is the wealth company has been able to create by its own and its employees efforts during a period. We may define the value added as the excess of net sales revenue adjusted with increases or decreases of semifinished and finished stock plus income from other services over the cost of bought-in-goods and services purchased from outside agencies.

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Classification and Computation Value added may be classified into two categories
a) Gross Value Added(GVA):
o

It refers to sales plus income from other service less bought in materials and services purchased from outsiders. Two methods: 1. Additive Method GVA=Profit before tax + Employee cost + Depreciation + Interest 2.Subtracting Method GVA=Sales + Income from services-Cost of bought in goods and services
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b) Net Value Added(NVA): It refers to the difference between GVA and Depreciation. In other words, NVA is the sum of value added to employees, to providers of loan capital, to Government and to owners. o Two Methods: 1. Income Distribution Method NVA=Value added to workers+ Value added to government+ Value added to financer+ Value added to entity 2. Net Output Method NVA=GVA-Depreciation =(Sales+ Income from other services)cost of bought-in-goods and service depreciation.

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Significance Of Value Added

The value added income concept is a significant tool for

appraising the performance of enterprises whose operation effects the social and economic well-being of entire community. It recognizes other contributors and claimants who have contributed in the process of generating value such as employees, government and providers of loan capital. Everyone of them contributes to the value added and gets a proportionate share therein. At the time of preparing plans and targets of the company, financial managers usually set a profit target, but the value added could be a more appropriate criterion in this matter. Value added determines reward for employees and providers of capital
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VALUE ADDED STATEMENTS

Meaning, Definition and Significance For the purpose of calculating the amount of value added

and its distribution, the value added statement is prepared. Value added statement may be defined as the statement, which shows the income of the company as an entity and how that is divided between people who have contributed to its creation. It reveals the value added by an enterprise which it has been able to generate and its distribution among those contributing to its generation known as stakeholders. The value added statement reports on the calculation of value added and its application among its stakeholders in the company

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Origin and development

The concept of value added income was first introduced in

the computation of national income. ASSC has recommended various expansions in financial reporting in order to improve and enhance both the understandability and reliability of traditional financial statements and techniques. As a result, supplementary financial statements have been developed and the companies are advised to prepare statements like Value added statement. A review of the publication of the VAS around the world has indicated that a significant number of companies in the Netherlands, France and Germany have provided value added data.
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Assumptions in VAS
Following assumptions are made to derive the value added income through the preparation of Value Added Statement(VAS): i. VAS is not a substitute but a supplement to the Profit and Loss Account. ii. It is prepared on the basis of data recorded and processed by the conventional accounting system. iii. In the preparation of VAS the accounting concepts and principles of accounting are remaining the same

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Objectives Of VAS
To disclose the value added by a firm during a period of time ii. To indicate the wealth created by the firm measuring the performance of the business unit. iii. To study the pattern of distribution of value added to all the stakeholders. iv. To use it as the basis for making inter-firm and intra-firm analysis for improvement in team spirit, etc. v. To collect revenue by way of levying tax on value added instead of on net profit. vi. Format of VAS.
i.
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Uses of VAS

Value added shown in VAS can be used to measure the business performance in a better way. VAS is more useful to the employees of a company rather than Profit and Loss statement. VAS is used to construct VA-base ratios that are considered as the important diagnostic and predictive tool for making comparison of companys performance. VAS, a supplementary report is useful to provide means for a company to reach out to an expanded audience of users. It improves the attitude of employees towards their employing organization.
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 Value added income data shown in VAS will aid government agencies in planning for the future by providing them with current information on the output. It can also be used to assist in capital investment appraisal by comparing the value added available from different investment proposals. It also provides important accounting and other information that facilitates better communication from a concern to a variety of users. At present, the both Central and various State Governments use VAS to determine and collect tax on value addition by an enterprise in its process of production. It helps to estimate resources needed for a particular level of activity and therefore, it helps in preparing budgets.
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Limitations of VAS
VAS may lead to confusion especially in cases where wealth is

increasing while earnings or other value added components are decreasing. The inclusion of the value added may wrongly lead management to pursue maximization of firms value. The nave approach to the interpretation of a firms value added statement can create fallacies such as-increasing value added must increase profit and increasing value added per unit of labor must benefit shareholders and so on. There is lack of uniformity/consistency among different companies in the matter of preparation and presentation of value added measures.
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 VAS is nothing more than a mere rearrangement of the data obtained from Profit and Loss Account of shifting focus of attention from the profit and loss figures to the figures of mainly employees remuneration. The inclusion of VAS in the Annual Report of a company involves extra cost and work. So it may create delay in annual reporting In spite of these limitations the Value Added Statement brings about certain changes in emphasis rather than change in the content of the traditional financial statement and hence such change leads to the change in the attitude and behavior of companys workforce.
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Submitted by: Cheenu Jain Gaden dickyi Shruti s Preeti rani Nayana hegde

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