Economic Value Added
Economic Value Added
Economic Value Added
ON
Prepared By,
Pankaj Motwani(11018)
Purvish Shah(11039)
What is EVA?
where,
EVA = economic value added
NOPAT = net operating profit after tax
c* = cost of capital
CAPITAL = economic book value of the capital employed in the firm
r = return on capital = NOPAT/CAPITAL
PAT = profit after tax
INT = interest expense of the firm
t = marginal tax rate of the firm
ke = cost of equity
EQUITY = equity employed in the firm
For example,
CAPITAL : 10,000
NOPAT : 2,000
c* : 15%
r : 20%
EVA = CAPITAL*(r-c*)
= (10,000)(0.2-0.15)
= 500
What causes EVA to increase?
Cost of Capital
Cost of Capital should have the following features:
• It represents a weighted average of all the costs of all sources of capital
• It is calculated in post-tax terms
• It reflects the risks borne by various providers of capital
Capital Employed
•We need to make adjustments in the ‘accounting’ balance sheet to derive the
‘economic book value’ balance sheet.
•To reflect the economic value of assets rather than the accounting values
What Does EVA Show?
• +Ve The Company has Managed to
create Shareholder Value
YEAR 1 2 3 4 5 6 7
Beginning
Capital 50 60 72 86.4 96.76 108.38 117.05
NOPAT 6 7.2 8.64 10.36 11.61 13.00 14.04
Cost of
Capital(%) 11 11 11 11 11 11 11
Capital
Charge 5.5 6.6 7.92 9.504 10.64 11.92 12.87
EVA 0.5 0.6 0.72 0.864 0.96 1.08 1.18
Growth
Rate(%) 20 20 20 12 12 8 8
The present value of the EVA stream is
Steps
•Develop Top Management Commitment
•Customize the definitions of EVA
•Identify EVA centres
•Analyze the drivers of EVA
•Tailor an incentive compensation system
•Train all the employees
Problems in using EVA