1.

1 INTRODUCTION
Introduction and origin: The aim of any professional organization is to maximize the wealth of share holders, which is measured by the returns they receive on their investment. Returns are in two parts, first is in the form of dividends and the second in the form of capital appreciation reflected in the market value of shares. But the market value of shares is influenced by a lot of factors, many of which may not be fully influenced by the management of a firm. However one factor which has a significant influence on the market value is the expectation of the shareholders regarding the return on the investment. The question then arises is which measure of corporate performance is liked to be expectation of the shareholders. Various measures like Earnings Per Share (EPS), Return On Equity (ROE), Return On Investment (ROI) and Return On Capital Employed (ROCE) have been used to evaluate the performance of the business. The problem with these performance measures is that they lack a proper bench mark for comparison. Because they ignore the minimum rate of return on investment expected by the share holders. To overcome this problem the consultancy firm Stern Stewart came up with a performance measure that takes into account the minimum returns required by the shareholders. They called this measure the Economic Value Addition (EVA) Definition & calculation of EVA : EVA is the return a firm earns in excess of the minimum required by the investors. As for the formal definition, EVA is calculated using the following formula. EVA = NOPAT (WACC ^ CE) Where, NOPAT = Net operating profit after tax. WACC = Weighted Average cost of capital

CE = Capital employed Weighted average cost of capital is the weighted average of the cost of debt cost of equity and cost of preference capital with weightages equivalent to the proportion of each in the total capital. NOPAT is measured from the income statement by adding back interest payments and subtracting and adding non operating income and expenses respectively to the net profit figure. Capital employed consists of adjusted equity share holders fund, all interest bearing obligations and preference capital. Improving EVA: Following are the ways in which the EVA can be improved Increasing NOPAT with the same amount of capital Reducing the capital employed without affecting the earnings ie discarding the unproductive assets. Investing in those projects that earn a return greater than the cost of capital. Reducing the cost of capital,, which means employing more debt, as debt is cheaper than equity or preference capital. EVA Barometer for Better Management : EVA forces the management to expressly recognize its cost of equity and to take that cost into account in all its decision. It measures the amount of value a firm creates during a definite period through operating decisions that improve margins, efficiently utilize its production facilities, improve management of working capital and redeploy under utilized assets. Thus EVA can be used to hold management accountable for all economic outlays whether they appear in the income statement, on the balance sheet or in the foot notes to financial statement.

Draw backs of EVA: It ignores inflation. So it is biased against new assets. Whenever a new investment is made capital charge is on the full cost initially, so EVA figure is low. But as the depreciation is written off the capital charge decreases and hence EVA goes up. Since EVA is measured in Rupee terms it is biased in favour of large, low return businesses. Large businesses that have returns only slightly above the cost of capital can have higher EVA than smaller businesses that earn returns much higher than the costs. Short term EVA can be improved by reducing assets faster than the earnings and if this is pursued for long it can lead to problems in the longer run when new improvements to the asset base are made. Corporate facts : According to the Economic Times Research Bureau, the aggregate EVA of the 100 large sample companies works out to just Rs. 95 crore in excess of what the same capital could generate had it been invested at 13 % rate of interest. Any system will bear fruits only when it is well implemented and has the support of all the parties concerned and EVA is no exception to this rule. Moreover as with any other system EVA too has limitations but it still stands as an improvement over measures like ROI and ROE and if implemented will be taking the limitations into account will yield better results.

1.2 INDUSTRY PROFILE

INDIAN POWER SECTOR The power sector has registered significant progress since the process of planned development of the economy began in 1950. Hydro -power and coal based thermal power have been the main sources of generating electricity. Nuclear power development is at slower pace, which was introduced, in late sixties. The concept of operating power systems on a regional basis crossing the political boundaries of states was introduced in the early sixties. In spite of the overall development that has taken place, the power supply industry has been under constant pressure to bridge the gap between supply and demand. Growth of Indian power sector Power development is the key to the economic development. The power Sector has been receiving adequate priority ever since the process of planned development began in 1950. The Power Sector has been getting 18-20% of the total Public Sector outlay in initial plan periods. Remarkable growth and progress have led to extensive use of electricity in all the sectors of economy in the successive five years plans. Over the years (since 1950) the installed capacity of Power Plants (Utilities) has increased to 89090 MW (31.3.98) from meagre 1713 MW in 1950, registering a 52d fold increase in 48 years. Similarly, the electricity generation increased from about 5.1 billion units to 420 Billion units 82 fold increase. The per capita consumption of electricity in the country also increased from 15 kWh in 1950 to about 338 kWh in 1997-98, which is about 23 times. In the field of Rural Electrification and pump set energisation, country has made a tremendous progress. About 85% of the villages have been electrified except farflung areas in North Eastern states, where it is difficult to extend the grid supply. Structure of power supply industry In December 1950 about 63% of the installed capacity in the Utilities was in the private sector and about 37% was in the public sector. The Industrial Policy Resolution of 1956 envisaged the generation, transmission and distribution of power almost exclusively in the public sector. As a

result of this Resolution and facilitated by the Electricity (Supply) Act, 1948, the electricity industry developed rapidly in the State Sector. In the Constitution of India "Electricity" is a subject that falls within the concurrent jurisdiction of the Centre and the States. The Electricity (Supply) Act, 1948, provides an elaborate institutional frame work and financing norms of the performance of the electricity industry in the country. The Act envisaged creation of State Electricity Boards (SEBs) for planning and implementing the power development programmes in their respective States. The Act also provided for creation of central generation companies for setting up and operating generating facilities in the Central Sector. The Central Electricity Authority constituted under the Act is responsible for power planning at the national level. In addition the Electricity (Supply) Act also allowed from the beginning the private licensees to distribute and/or generate electricity in the specified areas designated by the concerned State Government/SEB. During the post independence period, the various States played a predominant role in the power development. Most of the States have established State Electricity Boards. In some of these States separate corporations have also been established to install and operate generation facilities. In the rest of the smaller States and UTs the power systems are managed and operated by the respective electricity departments. In a few States private licencees are also operating in certain urban areas. From, the Fifth Plan onwards i.e. 1974-79, the Government of India got itself involved in a big way in the generation and bulk transmission of power to supplement the efforts at the State level and took upon itself the responsibility of setting up large power projects to develop the coal and hydroelectric resources in the country as a supplementary effort in meeting the countrys power requirements. The National thermal Power Corporation (NTPC) and National Hydroelectric Power Corporation (NHPC) were set up for these purposes in 1975. North-Eastern Electric Power Corporation (NEEPCO) was set up in 1976 to implement the regional power projects in the North-East. Subsequently two more power generation corporations were set up in 1988 viz. Tehri Hydro Development Corporation (THDC) and Nathpa Jhakri Power Corporation (NJPC). To construct, operate and maintain the inter-State and interregional

transmission systems the National Power Transmission Corporation (NPTC) was set up in 1989. The corporation was renamed as POWER GRID in 1992. Current problem of power sector The most important cause of the problems being faced in the power sector is the irrational and unremunerative tariff structure. Although the tariff is fixed and realized by SEBs, the State Governments have constantly interfered in tariff setting without subsidizing SEBs for the losses arising out of State Governments desire to provide power at concessional rates to certain sectors, especially agriculture. Power Supply to agriculture and domestic consumers is heavily subsidized. Only a part of this subsidy is recovered by SEBs through cross subsidization of tariff from commercial and industrial consumers. The SEBs, in the process, have been incurring heavy losses. If the SEBs were to continue to operate on the same lines, their internal resources generation during the next ten years will be negative, being of the order of Rs.(-) 77,000 crore. This raises serious doubts about the ability of the States to contribute their share to capacity addition during the Ninth Plan and thereafter. This highlights the importance of initiating power sector reforms at the earliest and the need for tariff rationalization. Power sector reforms The Orissa Government was the first to introduce major reforms in power sector through enactment of Orissa Reforms Act, 1995. Under this Act, Orissa Generating Company, Orissa Grid Company and Orissa Electricity Regulatory Commission have been formed. Similarly, the Haryana Government has also initiated reform programme by unbundling the State Electricity Board into separate companies and Haryana Electricity Regulatory Commission has already been constituted. With a view to improve the functioning of State Electricity Boards, the Government promulgated the State Electricity Regulatory Commission Act for establishment of Central Electricity Regulatory Commission at the national level and State Electricity Regulatory Commission in the States for rationalisation of tariff and the matters related thereto. Subsequent to the enactment of ERC Act, 1998 more and more States are coming up with an action plan to undertake the reform programmes. In this respect, Governments of Uttar Pradesh, Rajasthan,
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Madhya Pradesh, Goa, Karnataka and Maharashtra have referred their proposals for setting up independent regulatory mechanism in their States. The Electricity (Amendment) Act 1998 was passed with a view to make transmission as a separate activity for inviting greater participation in investment from public and private sectors. The participation by private sector in the area of transmission is proposed to be limited to construction and maintenance of transmission lines for operation under the supervision and control of Central Transmission Utility (CTU)/State Transmission Utility (STU). On selection of the private company, the CTU/STU would recommend to the CERC/SERC for issue of transmission license to the private company. In this regard, the Government of Karnataka is the first to invite private sector participation in transmission by setting up joint-venture company. Other States are also in the process of introducing the reforms in the transmission sector. In view of the urgent need to reduce transmission and distribution losses and to ensure availability of reliable power supply to the consumers reforms in the distribution sectors are also been considered by establishing distribution companies in different regions of the State. The entry of private investors will be encouraged wherever feasible and it is proposed to carry out these reforms in a phased manner. The Governments of Orissa and Haryana have already initiated reforms in the distribution sector by setting up distribution companies for each zone within their States. With these efforts, it is expected that the performance of power sector will improve because of rationalisation of tariff structures of SEBs and adequate investment for transmission and distribution sector.

1.3

COMPANY PROFILE

BHEL is the largest engineering and manufacturing enterprise in India in the energyrelated/infrastructure sector, today. BHEL was established more than 40 years ago, ushering in the indigenous Heavy Electrical Equipment industry in India - a dream that has been more than realized with a well-recognized track record of performance. The company has been earning profits continuously since 1971-72 and paying dividends since 1976-77. BHEL manufactures over 180 products under 30 major product groups and caters to core sectors of the Indian Economy viz., Power Generation & Transmission, Industry, Transportation, Telecommunication, Renewable Energy, etc. The wide network of BHEL's 14 manufacturing divisions, four Power Sector regional centres, over 100 project sites, eight service centres and 18 regional offices, enables the Company to promptly serve its customers and provide them with suitable products, systems and services -- efficiently and at competitive prices. The high level of quality & reliability of its products is due to the emphasis on design, engineering and manufacturing to international standards by acquiring and adapting some of the best technologies from leading companies in the world, together with technologies developed in its own R&D centres.

BHEL has acquired certifications to Quality Management Systems (ISO 9001), Environmental Management Systems (ISO 14001) and Occupational Health & Safety Management Systems (OHSAS 18001) and is also well on its journey towards Total Quality Management.

BHEL has Installed equipment for over 90,000 MW of power generation -- for Utilities, Captive and
Industrial users.

BHEL has Supplied over 2,25,000 MVA transformer capacity and other equipment operating in Transmission & Distribution network up to 400 kV (AC & DC).

BHEL has Supplied over 25,000 Motors with Drive Control System to Power projects, Petrochemicals, Refineries, Steel, Aluminum, Fertilizer, Cement plants, etc.

BHEL has Supplied Traction electrics and AC/DC locos to power over 12,000 kms Railway network. BHEL has Supplied over one million Valves to Power Plants and other Industries. BHEL's operations are organized around three business sectors, namely Power, Industry including Transmission, Transportation, Telecommunication & Renewable Energy - and Overseas Business. This enables BHEL to have a strong customer orientation, to be sensitive to his needs and respond quickly to the changes in the market. BHEL's vision is to become a world-class engineering enterprise, committed to enhancing stakeholder value. The company is striving to give shape to its aspirations and fulfill the expectations of the country to become a global player. The greatest strength of BHEL is its highly skilled and committed 42,600 employees. Every employee is given an equal opportunity to develop himself and grow in his career. Continuous training and retraining, career planning, a positive work culture and participative style of management ? all these have engendered development of a committed and motivated workforce setting new benchmarks in terms of productivity, quality and responsiveness.

BHEL ACHIEVEMENTS:
1. Minister for Heavy Industries and Public Enterprises, Shri Manohar Joshi laid a foundation stone on July 14, 2000 for a deinking Plant in Hindustan Newsprint Ltd., Kottayam, Kerala at a cost of Rs.52.20 cr. This would improve the financial health of the company and reduce dependence on forest resources. 2. A turnaround plan for HMT Ltd. was approved by the Govt. in July, 2000. The major elements of financial and organisational restructuring include fresh infusion to the extent of Rs.395 crs. by Govt., formation of subsidiaries for machine tools & Watch business groups, closing of 5 unviable units and offer of VRS to employees.
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3. An Industrial Show was organised in Rajkot sponsored by the Ministry of Heavy Industries & Public Enterprises with the aim of increasing co-operation in heavy and small scale industries. Some of the major PSEs of DHI participated in the show. 4. The management of Lagan Jute Machinery Company Limited (LJMC), a subsidiary of Bharat Bhari Udyog Nigam Limited (BBUNL) has been handed over to M/s.Murlidhar Ratanlal Exports Limited (MREL) ( on 4.7.2000) by way of transfer of 6330 shares of LJMC in favour of MREL. 5. In some of the sick PSEs considered unviable by the BIFR/Expert Agency, Govt. have introduced a Voluntary Separation Scheme (VSS) providing benefits of VRS as a safety net to the employees of the PSEs facing the prospects of closure. VSS provides benefit of ex-gratia under VRS which is much higher than the compensation under the ID Act, 1947. 6. Govt. approved financial restructuring and a package of assistance for Hindustan Cables Ltd, which was implemented from 1.4.1999. The company achieved highest ever production of Rs.784 cr. in 1999-2000 against a production of Rs.217 cr. in 1998-99. 7. Maruti Udyog Ltd. launched three new models namely Baleno Altura, Alto-LX and AltoVX. 8. BHEL registered a substantial jump in the physical export order booking of Rs.703 cr. in 1999-2000 against a booking of Rs.69 crs. in 1998-1999. In the current year 2000-2001 also the company has bagged orders of Rs.650 crs. already (upto Nov. 2000) in the international business segment. 9. Bharat Heavy Electricals Limited (BHEL) bagged the following major orders:i. Two orders worth Rs.100 cr. and Rs.75 cr. from Indian Oil Corporation Limited (IOC), envisaging manufacture, supply, erection and commissioning of 30 MW & 20 MW Gasbased cogeneration power plant respectively, for their Panipat Refinery in Haryana and Barauni Refinery in Bihar. An order worth Rs.25 cr. against stiff international competition from Tehri Hydro Development Corporation (THDC) envisaging complete design, manufacture, testing, erection and commissioning of 4 Nos. 306 MVA, 15.75 MV/400 KV three-phase Generator Transformers for their 1000 MW Tehri Hydro Project in Uttar Pradesh. An Asian Development Bank (ADB) funded order from Arunachalam Sugar Mills Limited for 4 MW Steam Turbine-Generator (STG) for their Cogeneration Power Plant at Thiruvannamalai in Tamil Nadu. Setting up of Frame 9 Gas Turbine based Power Plant on turnkey basis at Baghabari, Bangaladesh from the Bangladesh Power Development Board, Government of Bangladesh, valued at Rs.106 crore.

ii.

iii. iv.

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viii. ix. x.

xi.

xii. xiii. xiv.

xv. xvi. xvii.

An order worth Rs.250 cr., against stiff International Competition, from NALCO for its captive power plant at Angul in Koraput District of Orissa. An order valued at Rs.810 crores from Delhi Vidyut Board for setting up an environment friendly, 330 MW, gas based power project in Delhi, to be commissioned in 30 months time. Two largest ever export orders cumulatively valued at Rs.870 Crores for manaufacture and supply of large size Gas Turbine Generating Units to Government of Iraq under the United Nations "Oil for Food" program. These orders are of special significance, as they envisage the highest rating, 159 MW, Power Plant equipment ever exported from India. Eco-friendly Advance Class Gas Turbine for a 95 MW Perungulam Combined Cycle Power Plant (CCPP) of Tamil Nadu Electricity Board (TNEB) valued at Rs.295 crores. A turnkey order from Indian Oil Corporation (IOC) for setting up an energy efficient & environment friendly 20 MW co-generation power plant at Digboi Refinery Complex in Assam. An order for a state-of-the-art Vessel Traffic Management System (VTMS) from the New Mangalore Port Trust. The order was won by consortium of BHEL with Japan Radio Company. With this order, BHEL marks its entry into the Port Automation business areas. An order worth Rs.365 crore from Karnataka Power Corporation Limited (KPCL) for setting up 210 MW unit at Raichur thermal power station with synchronization targeted in a period of 28 months, thereby setting a benchmark in schedule for commissioning of new projects in the country. Order for supply of 11 numbers of flame proof motors upto 900 KW capacity ratings from Ingersoll Dresser Pumps (IDP), UK. First ever export order an Independent Power Project (IPP) in Sri Lanka for manufacture and supply of Gas Turbine generating equipment (124 MW ISO rating) along with associated auxilliaries and spares, valued at Rs.131 cr. Largest ever overseas turnkey substation contract (330KV) valued at Rs.68 crore, for setting up of a new substation at Lusaka West besides rehabilitation of 11 existing 330 KV & 132 KV class substations, located in different parts of Zambia, being funded by the World Bank. An order for the design, manufacture, supply and testing of one number Hydro Turbine (Kaplan type) of 15 MW for unit 4 of Kurichu Hydro Electric Project (HEP) in Bhutan. An order for Steam Generators from Hindalco Industries Limited (Hindalco), valued at Rs.125 crore for enhancing the capacity of Hindalcos captive power plant at Renusagar in Uttar Pradesh. A 24 MW Steam Turbine Generator (STG) set by Rama Newsprint and Papers Limited (RNPL) for their steam turbine based cogeneration power plant at Surat in Gujarat.

10. Some other achievements of BHEL are as under : i. ii. Achieved a milestone by synchronising the second Unit of 250 MW in a record time of 20.5 months at Suratgarh Thermal Power Station (Stage I) in Rajasthan. An employee of BHELs Seamless Steal Tube Plant,.Tiruchirapalli, won the coveted Prime Ministers Shram Bhushan Award.

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iii. iv. v.

vi.

vii.

viii.

ix.

Won the All India Trophy for Top Exporters, in the cataegory of Engineering Consultancy, Technical know-how & other Engineering Services Exporters, for the year 1998-99 for outstanding export performance. Bangalore plant became the first electronic equipment manufacturing unit to receive the coveted ISO-14001 certification of Det Norske Veritas (DNV). Amongst public and private sector companies in the country, BHEL has been adjudged the best organisation, for honest and prompt payment of customs duties. For the second consecutive years, since its inception in 1998-99, the prestigious Samman Patra 19992000 instituted by Ministry of Finance has been awarded to the Company for their unblemished track record with Airport Customs in terms of payment of Custom Duties. Employees of BHEL contributed a sum of Rupees One Crore to the Prime Ministers National Relief Fund. A cheque to this effect was presented by Shri K.G.Ramachandran, CMD, BHEL, to Shri Manohar Joshi, Union Minister for Heavy Industries and Public Enterpriese in New Delhi on 27th September,2000. BHEL has become the first company in the country capable of offering indigenously developed Ceramic Disc Insulators for + 500 KV High Voltage Direct Current (HVDC) applications. BHEL has achieved yet another landmark in the high-tech area of High Voltage Direct Current (HVDC) technology, with the commissioning of the 200 MW, 200 KV National HVDC project (Stage-II). This project has linked the 196 km. DC transmission line between Barsoor in Chhatisgarh and Lower Sileru in Andhra Pradesh. With this, India has joined a select band of advanced countries in the world capable of executing stateof-the-art HVDC projects. The project has been jointly funded by the Department of Heavy Industry, Ministries of Power & Information Technology, BHEL and the two utilities APSEB and MPEB. BHEL successfully commissioned 600 MW Ranjit Sagar Hydro Electric Project (HEC) in Punjab which is expected to ease the power situation in the power deficit State of Pubjab and cater to the power requirements of Himachal Pradesh and Jammu & Kashmir. BHEL successfully executed an export order for specially designed valves for the Petroleum Industry in Taiwan. These special purpose valves designed and developed indigenously have been exported to Taiwan for the first time in a tight schedule of just 3 months. Among public and private sector companies, BHEL bagged the highest award of its kind in the country from the Indian Value Engineering Society for adopting Value Management as an organised corporate activity. BHEL has entered into Technical Collaboration with MAX Control Systems Inc. USA, one of the world leaders in the field, for the manufacture of new generation Distributed Control Systems called MAX 1000+Plus. This system offers extremely fast response time resulting in higher efficiency, reliability, low operating costs and safer plant operation. BHEL won prestigious award namely "Golden Peacock National Quality Award 1999" instituted by the Institute of Directors (IOD) for achieving excellence in quality conforming to global standards.
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12 National Safety Awards have been won by BHELs plants located at Bhopal, Hyderabad, Bangalore, Ranipet and Jagdishpur for outstanding achievements in terms of highest accident free period and lowest accident frequency rate. The awards were presented by Dr.Satyanarayan Jatiya, Union Minister of Labour on 17th September, 2000.

11. Braithwaite, Burn & Jessop (BBJ) bagged following major orders during the year : i. ii. Order for construction of Fourth Krishna Bridge near Vijayawada valued at Rs.19.86 cr. Order for construction of 3 major bridges under North Frontier Railway in Siliguri Bongaigaon Gauge Conversion Bridge against stiff competition valued at Rs.13.42 cr.

12. BBJ also diversified into marine related activity and procured a dredging order valuing Rs.9 cr. from West Bengal Fisheries Corpn. Ltd. 13. Salem Works of Burn Standard Co.Ltd. (BSCL) obtained ISO-9002 accredition during the year for its Magnesia production activities. 14. Ministry of Labour, the Appropriate Authority, have granted permission for closure of Rehabilitation Industries Corporation Limited (RIC) and Weighbird India Limited (WIL) in pursuance of the Government decision to close down six sick and unviable PSEs. Action for closure of other sick PSEs is under process. 15. Machine Tools Division of HMT introduced a no. of new products like Cylindrical Grinder PCG 130 APG, Drill Tap Centre DT40, Turning Centre Stallian 100, Vertical Machining Centre VCM 400 and VMC 800S. 16. As many as 15 new models were added by HMT for Mechanical Watches and 99 new models for Quartz Watches. 17. HMT launched two new models of Tractors. Model 7511, a heavy duty tractor for dry land cultivation and Model 3522 DX for ploughing and haulage work. 18. HMT implemented Entrepreneur and Technical Development Centre (ETDC) at Dakar, Senegal under contract from Ministry of External Affairs, Government of India. The scope of Project covered supplies and installation of machines and equipment, civil and Electrical and deputation of Experts for imparting on-the-job training. 19. HMT was associated with Govt. of India funded contract for setting up Tool Shop Extension Project in Nepal. The company has also secured an order for setting up a tool room project in Turkmenistan.

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20. Scooters India Ltd. (SIL) upgraded its model Vikram 750D which was type approved to meet the pollution norms. Another model 410D has been re-designed and type approved meeting pollution norms was introduced as Vikram 450D. 21. Engineering Projects (India) Limited (EPI) bagged following major orders : i. order worth Rs.12 cr. which envisages construction of Rain Water (RW) Reservoir, RW Pump House, Civil work Forebay and pump house and other allied works, from National Thermal Power Corporation Limited (NTPC) for their Suratgarh Thermal Power Station (STPS), suratgarh, Rajasthan, two projects Kothagudem Collieries, Andhra Pradesh and Gangapur Dam, Nashik Valuing Rs.32.73 crs. for carrying out various civil construction works. Sardar Sarovar Canal based Drinking Water Project for supply of water to Bhavnagar, District Gujarat, valued at Rs.61.85 cr. Execution of Zero Flaring facilities at Gandhar, Gujarat, valued at Rs.18.45 cr. Three projects valuing Rs.29.19 crores for construction of residential staff quarters at Juhu Aerodrome at Mumbai for Pawan Hans Helicopters Limited (Rs.16.81 crores), Turnkey contract for laying Docklines at Paradeep (Orissa) for IOC (Rs.12.09 crores) and Project Management Consultancy for development of industrial area on GT Road for Greater Noida Authority (Rs.0.29 crores).

ii. iii. iv. v.

22. Prime Ministers MOU Award-Merit Certificate was awarded to EPI for Excellence in the Achievement of MOU targets for the year 1998-99. EPI achieved the distinction of being amongst the top ten MOU signing companies. 23. Instrumentation Limited have bagged an order for Renovation & modernisation of Santaldih Power Plant in West Bengal at a cost of over Rs.13 crores. 24. Hindustan Paper Corporation (HPC) has been given the CAPEXIL award for its outstanding export performance in 1999-2000 when it exported a total of 12147 tonnes of paper valued at about Rs.27 crs. to Bangladesh, Sri Lanka, Egypt and Mynmar. 25. Amongst public and private sector companies in the country, BHEL won the maximum number of Vishwarkarma Rashtriya Puraskar for the years 1997 and 1998. During this period, seven National safety awards were also bagged by the company.

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PRODUCT PROFILE
Established in the late 50s, Bharat Heavy Electricals Limited (BHEL) is, today, a name to reckon with in the industrial world. It is the largest engineering and manufacturing enterprise of its kind in India and one of the leading international companies in the power field. BHEL offers over 180 products and provides systems and services to meet the needs of core sectors like: power, transmission, industry, transportation, oil & gas, non-conventional energy sources and telecommunication. A wide-spread network comprising 14 manufacturing divisions, 8 service centres, 4 power sector regional centres, 18 regional offices, besides a large number of project sites spread all over India and abroad, enables BHEL to be close to its customers and cater to their specialised needs with total solutions - efficiently and economically. An ISO 9000 certification has given the company international recognition for its commitment towards quality. With an export presence in more than 60 countries, BHEL is truly Indias industrial Ambassador to the world. PRODUCT RANGE This list is intended as a general guide and does not represent all of BHEL's products and systems. THERMAL POWER PLANTS Steam turbines and generators of up to 500MW capacity for utility and combined-cycle applications; capability to manufacture steam turbines with super critical steam cycle parameters and matching generator up to 1000 MW unit size. Steam turbines for CPP applications; capability to manufacture condensing, extraction, back pressure, injection or any combination of these types. GAS BASED POWER PLANTS Gas turbines of up to 260MW (ISO) rating. Gas turbine based co-generation and combined-cycle systems for industry and utility applications.

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HYDRO POWER PLANTS Custom-built conventional hydro turbines of Kaplan, Francis and Pelton types with matching generators, pump turbines with matching motor-generators. Mini/micro hydro sets. Spherical, butterfly and rotary valves and auxiliaries for hydro station

DG POWER PLANTS HSD, LDO, FO, LSHS, natural-gas/biogas based diesel power plants, unit rating up to 20MW and voltage up to 11kV, for emergency, peaking as well as base load operations on turnkey basis. INDUSTRIAL SETS Industrial turbo-sets of ratings from 1.5 to 120MW. Gas turbines land matching generators ranging from 3 to 260MW (ISO) rating. Industrial stream turbines and gas turbines for drive applications and co-generation applications. BOILERS Steam generators for utilities, ranging from 30 to 500MW capacity, using coal, lignite, oil, natural gas or a combination of these fuels: capability to manufacture boilers with super critical parameters up to 1000 MW unit size. Steam generators for industrial applications, ranging from 40 to 450t/hour capacity using coal, natural gas, industrial gases, biomass, lignite, oil, bagasse or a combination of these fuels. Pulverized fuel fired boilers. Stoker boilers. Atmospheric fluidized bed combustion boilers. Circulating fluidized bed combustion boilers.

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Waste heat recovery boilers. Chemical recovery boilers for paper industry, ranging from capacity of 100 to 1000 t/day of dry solids. Pressure vessels.

BOILER AUXILIARIES
Fan

Axial reaction fans of single stage and double stage for clean air application, with capacity ranging from 25 to 800m3/s and pressure ranging from 120 to 1,480 m of gas column.

Axial impulse fans for both clean air and flue gas applications, with capacity ranging from 7 to 600m3/s and pressure up to 700 m of gas column. Single and double-suction radial fans for clean air and dust-laden hot gases applications up to 400oC, with capacity ranging from 4 to 600m3/s and pressure ranging from 150 to 1,800 m of gas column.

Air-Pre-heaters Ljungstrom rotary regenerative air-pre-heaters for boiler and process furnaces. Large regenerative air-preheaters for utilities of capacity up to 1000 MW.

Gravimetric Feeders Pulverizes Bowl mills of slow and medium speed of capacity up to 100 t/hour. Tube mills for pulverizing low-grade coal with high-ash content.

Pulse Jet and Reverse Air Type Fabric Filters (Bag Filters) Electrostatic Precipitators

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Electrostatic precipitators of any capacity with efficiency up to 99.9% for utility and industrial applications.

Mechanical Separators Soot Blowers Long retractable soot blowers (travel up to 12.2m), wall deslaggers, rotary blowers and temperature probes and related control panels operating on pneumatic, electric or manual mode. Swivel arm type soot blowers for regenerative air-preheaters.

Valves High-pressure and low-pressure bypass valves for utilities. High and medium-pressure valves, cast and forged steel valves of gate, globe, non-return (swing-check and piston lift-check) types for steam, oil and gas duties up to 600 mm diameter, 250 kg/cm2 pressure and 540oC temperature. High-capacity safety valves and automatic electrical operated pressure relief valves for set pressure up to 200 kg/cm2 and temperature up to 550oC. Safety relief valves for applications in power, process and other industries for set pressure up to 175 kg/cm2 and temperature up to 565oC. Piping Systems, Constant Load Hangers, Clamp and Hanger components, variable Spring hangers for power stations upto 850 MW capacities, combined cycle plants, industrial boilers and process industries.

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HEAT EXCHANGERS AND PRESSURE VESSELS CS/AS/SS/Nonferrous shell and tube heat exchangers and pressure vessels. Air-cooled heat exchangers. Surface condensers. Steam jet air ejectors. Columns. Reactors, drums. LPG/propane storage bullets. LPG/propane store mounded vessels. Feed water heaters.

POWER DEVICES High power capacity silicon diodes, thyristor power devices and solar photovoltaic cells.

TRANSPORTATION EQUIPMENT AC Electric locomotive AC-DC Dual Voltage Electric locomotive. Diesel-Electric Shunting locomotive Diesel Hydraulic Shunting locomotive OHE Recording cum Test Car. Electric Traction Equipment (for diesel/electric locos electric multiple units, diesel multiple units and urban transportation systems). Traction motors. Transformers smoothing reactors. Traction generators/alternators. Rectifiers. Bogies.

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Vacuum circuit breakers. Auxiliary machines. Microprocessor-based electronic control equipment. Power converter/inverter. Static inverter for auxiliary supply. Loco control resistances i.e. field diverters, dynamic braking resisters and inductive shunts. Traction control gear.

OIL FIELD EQUIPMENT Oil Rigs: A variety of on-shore rigs, work-over rigs, mobile rigs, heli-rigs, desert rigs for drilling up to depths of 9,000 m, completer with matching draw-works and hoisting equipment including: Mast and substructure; Rotating equipment; Mud system including pumps; Power packs and rig electrics; Rig instrumentation; Rig utilities and accessories. Well Heads and Christmas Trees/Sub Sea Equipment Well Head and X-Mas Trees for working pressures up to 10,000 psi. Choke and kill manifolds. Mud valves. Full bore valves. Block valves. Mudline suspension system. Casing support system. Sub sea Well Heads.

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1.4 NEED FOR THE STUDY

The implementation of complete EVA based financial management gives managers superior information and superior motivation to make decisions that will create the greatest shareholders wealth in any publically owned or private enterprise

EVAs biggest selling point is its relative simplicity. EVA is really just an alternate way of viewing corporate performances. It can readily be broken down to the level of a division, a factory store or even the product line. If you had to rely on only one single performance number, economic profit is probably the best because it contains so much information : economic profit incorporates balance sheet data into an adjusted income statement metric

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1.5 OBJECTIVES OF THE STUDY

PRIMARY OBJECTIVE
To measure the performance of an enterprise through EVA technique.

SECONDARY OBJECTIVE
To choose a strategy that results in the maximum economic addition of shareholder value. To study the importance of EVA in enhancing the pay-for-performance attitude in the organization. To measure the true economic value of an enterprise that accounting omits.

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1.6 SCOPE OF THE STUDY

If you had to rely on only one single performance number, economic profit is probably the best because it contains so much information (mathematicians would call it elegant) : economic profit incorporates balance sheet data into an adjusted income statement metric. Economic profit works best for companies whose tangible asset (assets on the balance sheet) correlate with the market value of assets as is often the case with mature industrial companies. It is a residual performance metric, it conveniently summarizes into a single statistic the value created and beyond all financial obligations. As an operational metric, it helps managers clarify how they create value. Generally, they do it either by investing additional capital that produces returns above weighted average cost of capital , by reducing capital employed in a business, by improving returns by growing revenues or reducing expenses or by reducing the cost of capital.

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1.7 LIMITATIONS OF THE STUDY

Although some proponents argue economic profit is all you need, it is very risky to depend on an single metric. The companies least suited for economic profit are high growth, new economy and hightechnology companies, for whom assets are off balance sheet or intangible. EVA discourages big investments because the capital charge depresses EVA. This may be evened out due to depreciation charges over the useful life of the asset, thereby reducing the average capital employed. Unless fully loaded and all cash adjustments are made, economic profit can be subject to accrual distortions .For example , because net operating profit after taxes is after depreciation and amortization, a company that does not reinvest capital to maintain its plant and equipment can improve its accrual bottom line simply by virtue of the declining D&A line. This sort of attempt at boosting economic profit is known as harvesting the assets.

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2.1 REVIEW OF LITERATURE

Introduction The aim of any organization is to maximize the wealth of the shareholder, who own the organization and expect good long-term yield on their investment. This goal has often been ignored or at least misinterpreted. Earnings per share and Return on investment are used as the most important performance measures, although they do not theoretically correlate with the shareholder value creation very well. Stern Stewart & Co. pioneered the development of Economic Value Added (EVA) framework, which offers a consistent approach to setting goals and measuring performance, communicating with investors, evaluating strategies and allocating capital. EVA as a value based performance metric seeks to measure the periodic performance in terms of change in value. Maximizing EVA means the same as maximizing long-term yield on shareholders investment. It is the measure that captures the true economic profit of the organization. Economic Value Added Defined Economic Value Added (EVA) may be defined as the net operating profits after tax minus an appropriate charge for the opportunity cost of all capital invested in an enterprise. Thus EVA = Net Operating Profit after tax Weighted Average Cost of Capital Weighted average cost of capital is defined as the cost of equity share capital plus the post tax cost of debt multiplied by the debt equity ratio. Cost of equity capital is the opportunity return from an investment with same risk as the company has. Cost of equity is usually defined with Capital asset pricing model (CAPM). The estimation of cost of debt is naturally more straightforward, since its cost is explicit. Cost of debt includes also the tax shield due to tax allowance on interest expenses. EVA can be rewritten as EVA = (ROI WACC) x CAPITAL EMPLOYED EVA captures the fact that equity should earn at least the return that is commensurate to the risk that the investor takes. In other words equity capital has to earn at least same return as similarly risky investments at equity markets. If that is not the case, then there is no real profit made and actually the company operates at a loss from the viewpoint of shareholders. On the other hand if

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EVA is zero, this should be treated as a sufficient achievement because the shareholders have earned a return that compensates the risk Market Value Added Defined A return greater than the cost of capital adds to the value of the organization. Market Value Added for listed companies have been defined as the difference between the companys market and book value. In other words if the total market value of a company is more than the amount

of capital invested in it, the company has managed to create shareholder value. If the case is opposite, the market value is less than capital invested the company has destroyed shareholder value. Market Value Added = Companys total Market Value - Capital invested And with simplifying assumption that market and book value of debt are equal, this is the same as:

Market Value Added = Market Value of Equity - Book Value of Equity

Book value of equity refers to all equity equivalent items like reserves, retained earnings and provisions. In other words, in this context, all the items that are not debt (interest bearing or non-interest bearing) are classified as equity. Thus market value added tells us how much has been added or reduced from the shareholders investment. If a companys rate of return exceeds its cost of capital, the company will have a positive MVA and will sell on the stock markets with premium compared to the original capital. On the other hand, companies that have rate of return smaller than their cost of capital sell with discount compared to the original capital invested in company. Thus whether a company has positive or negative MVA depends on the level of rate of return compared to the cost of capital. All this applies also to EVA. Thus positive EVA means also positive MVA and vice versa.

Market Value Added = Present value of all future EVA

This relationship between EVA and MVA has its implications on valuation. By replacing the market value added with the present value of future EVA we can obtain the value of the company as:

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Market Value of Equity = Book Value of Equity + Present value of all future EVA

Diagrammatically it can be shown as:

EVA1 + EVA2 + (1+r) (1+r)2 -EVA1 + - EVA2 + (1+r) (1+r)2

Advantages of Economic Value Added o Measuring Profits the way shareholders count them: Peter Drucker has put the matter in a Harvard Business Review article as, "Until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it devours in resourcesUntil then it does not create wealth; it destroys it." EVA corrects this error by explicitly recognizing that when managers employ capital they must pay for it, just as if it were a wage. Management System: EVA can give companies a better focus on how they are performing, its true value comes in using it as the foundation for a comprehensive financial management system that encompasses all the policies, procedures, methods and measures that guide operations and strategy. The EVA system covers the full range of managerial decisions, including strategic planning, allocating capital, pricing acquisitions or divestitures, setting annual goals-even day-to-day operating decisions. In all cases, the goal of increasing EVA is paramount and thus removes a lot of confusion

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Financial measure line managers understand: EVA has the advantage of being conceptually simple and easy to explain to non-financial managers, since it starts with familiar operating profits and simply deducts a charge for the capital invested in the company as a whole, in a business unit, or even in a single plant, office or assembly line Ending the confusion of multiple goals: Most companies use a numbing array of measures to express financial goals and objectives. Strategic plans often are based on growth in revenues or market share. Companies may evaluate individual products or lines of business on the basis of gross margins or cash flow. Business units may be evaluated in terms of return on assets or against a budgeted profit level. Finance departments usually analyze capital investments in terms of net present value, but weigh prospective acquisitions against the likely contribution to earnings growth. EVA is the only financial management system that provides a common language for employees across all operating and staff functions and allows all management decisions to be modeled, monitored, communicated and compensated in a single and consistent way always in terms of the value added to shareholder investment.

Pitfalls of EVA EVA is a value based measure, and it gives in valuations exactly same the answer as discounted cash flow, the periodic EVA values still have some accounting distortions because EVA is after all an accounting-based concept, suffering from the same problems of accounting rate of returns (ROI etc.). In other words the historical asset values that distort ROI do distort EVA values also. EVA is the excess of ROI over WACC multiplied by the capital employed and thus as the ROI suffers from serious limitations of wrong periodizing and distortions caused by inflation the same gets incorporated in EVA also.
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Wrong Periodizing: In case on a single project the normal depreciation schedules cause the ROI and consequently EVA to be small at the beginning of a project and big at the end of the project. ROI is low at the beginning of the project as the capital base is high while at the latter stages the ROI shoots up because of the low capital base. Distortions caused by Inflation and Capital Structure: EVA is affected by the accounting policies. Thus in long run a higher EVA will be reported if for example R&D costs are charged to the income statements and are not capitalized. Similarly inflation brings about distortion in the value of assets and affects EVA. Paradox of EVA: We know that Market Value of Equity = Book Value of Equity + PV of all future EVA

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Thus the EVA valuation has two components book value and future EVA and by increasing the book value of equity we actually reduce the future EVA because of the capital costs and vice versa. Implications EVA is based on the common accounting based items like interest bearing debt, equity capital and net operating profit and it is usually always good when EVA increases and always bad when EVA decreases. Industries like telecom, forestry products, pharmaceuticals, semiconductors etc are the ones with very cyclical investments (not smooth over the years) and/or industries with very long investment horizon suffer most from the pitfalls of EVA. But even in such industries the EVA financial management system can be successfully implemented with changes in the accounting procedure like changes in depreciation schedule. In other industries with a lot of current (instead of fixed) assets and with short investment period EVA can be easily used to the benefit of the shareholders. Introduced by Stern Steward and Company, EVA purports to assess shareholder value by calculating the amount by which profits exceed the cost of capital. Some critics say that EVA has a low correlation to shareholder value. Companies that use EVA often try to increase short-term shareholder value by minimizing their cost of capital. Managers become reluctant to invest in future growth because capital that hasn't yet generated a profit reduces EVA. Such short-sighted approach can limit a company's growth. EVA does not fit Internet start-ups because earning a positive EVA isn't all that important -- the key for start-ups is developing the product pipeline. EVA is a good measure of performance but by itself the metric is not a good indicator of how much shareholder value a business is generating. Investors need a measure that does not penalize investment.

Economic value addition in business

The concept:

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In simple terms, economic value added is the profit that remains after deducting the cost of the capital invested to generate the profit. It is obvious that one can get richer if he invest money at a higher return than the cost of that money to him. The cost of the capital in the EVA equation includes equity capital as wellas debt capital. Calculating cost of debt is easy- it is basically the interest paid on the firms new debt. The equity calculation is more complex as it varies with the risk the shareholders takes. A company creates value only if the return of the capital is greater than the opportunity cost of it or the rate the investors could earn by investing in other security with same risk. If the result is positive then the firm created value over the period in question. The EVA is negative it is a value destroyer. EVA is a essentially a repackaging of sound financial management and corporate financial principles that have been around for long time. Computation of EVA 1. Economic capital = Shareholders equity + + + good will written off Capitalised cumulative unusual loss Deferred tax +minority interest +total debt

2. Net operating profit after tax (NOPAT) = Operating profit + _ _ Interest expense Unusual gain Taxes

3. Weighted average cost of capital(WACC)

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Cost of equity Cost of debt WACC = (average out) 4. EVA = NOPAT- (capitalWACC)

Lets now look at the overall calculation, which can be broken down into three sets of calculations. Each of these is the mathematical implication of one of the three main ideas supporting the entire economic profit system: IDEA Cash flows are the best indicators of performance. The accounting distortions must therefore be fixed. Some expenses are really investments and should be capitalised on the balance sheet. True investments must therefore be recognised. Equity capital is expensive(or at the very least nor free). This expense must therefore be accounted for. IMPLICATION Translate accrual based operating profit(EBIT) into cash based net operating profit after taxes(NOPAT). Reclassify some current expenses as balance-sheet(equity or debt) items. Deduct a capital charge for invested capital

Profits the way shareholders count them By taking all capital costs into account including the cost of equity, EVA shows the money value of wealth a business has created or destroyed in each reporting period. In other words, EVA is profit the shareholders define it. If the shareholders expect, say , a 10% return on their
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investment, they make money only to the extend that their share of after-tax operating profits exceeds ten percent of equity capital. Everything before that is just building up to the minimum acceptable compensation for investing in a risky enterprise. The pioneering studies of Stewart According to Stewart (1991:215), financial analysts Stern Stewart & Co. started tracking the best 1000 industrial and services companies in the United States of America (USA) in 1989, after he had become disillusioned with the company rankings of the magazine Business Week at the time. These rankings were based on market capitalization and not on performance. Stern Stewart & Co. began to rank companies based on MVA. As they had expected, the new rankings were dramatically different from the Business Week rankings. Taking the Stern Stewart 1000 companies as a point of departure and eliminating some companies for various reasons, such as incomplete information, Stern Stewart & Co. did some research on the EVA and MVA of 613 companies in the USA. The companies were ranked in terms of the average EVA for 1987 and 1988. The study was based on the average EVA and MVA for each of 25 groups of companies (making up the 613), as well as on changes in EVA and MVA. The groups were made up according to the companies rankings in terms of average EVA. The research found that for companies with a positive EVA, there was a very high level of correlation (as indicated by r2) between the level of EVA and the level of MVA, both for the average values used and the changes in values. The averages (per group of 25 companies) of the 1987 and 1988 EVA values showed an r2 of 97%, relative to the 1988 MVA values. The relationship for the changes in values was even better than that for the average values. For the groups of companies with a negative EVA, the correlation between the EVA and MVA levels was not as good. Stewarts (1991) explanation for this was that the market value of shares always reflects at least the value of net assets, even if the company has low or negative returns. The potential for liquidation, recovery, recapitalisation or a takeover sets a floor on the market value (in other words, the market value does not drop far below the net asset value).

Finegans extensions of the EVA and MVA applications

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Finegan (1991:36) extended the initial analysis discussed above to include other measures. He focused on the middle 450 companies (actually 467 companies out of the original 613) where the MVAs were tightly clustered and compared the power of EVA to that of more conventional measures such as EPS, growth in capital, return on capital and even growth in cash flow. The results of the regression of MVA against EVA and other common performance measures showed that EVA outperformed the other measures quite considerably with an r2 of 61%, compared to the second best other measure, which was return on capital, with an r2 of 47%. The explanatory power of EVA was found to be six times better than that of growth in EPS. Finegan (1991:36) then repeated the analysis of changes in MVA and again found EVA to be superior to the other measures. The r2 of changes in EVA was 44%, compared to an r2 of 35% for changes in return on capital, which was the measure that came closest to EVA in terms of its explanatory power. In this analysis, the r2 of EVA was about three times better than that of changes in EPS growth. Sterns comparison of EVA with popular accounting measures Stern (1993:36) argues that the key operating measure of corporate performance is not popular accounting measures such as earnings, earnings growth, dividends, dividend growth, ROE, or even cash flow, but in fact EVA. The changes in the market value of a selected group of companies (specifically their MVAs) have been shown to have a relatively low correlation with the above accounting measures. His research showed that the r2 for the relationship between MVA and various independent variables ranged from 9% for turnover growth to 25% for ROE rates. By comparison, the r2 for EVA relative to MVA was 50%. All the results were based on averages and they are set out in Table 1. Table 1 MVA vs other financial performance measures Correlation with MVA EVA ROE Cash flow growth EPS growth Asset growth R2 50% 25% 22% 18% 18%
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Dividend growth 16% Turnover growth 9% Source: Adapted from Stern (1993:36) Lehn and Makhijas work on EVA, MVA, share price performance and CEO turnover Lehn and Makhija (1996:36) conducted a study to find out how well EVA and MVA relate to share price performance and to see whether chief executive officer (CEO) turnover (the number of new CEOs during a given period) is related to EVA and MVA. They selected 241 large US companies and gathered information about them for the four years 1987, 1988, 1992 and 1993. About two thirds of the companies operated in the manufacturing industry. Six performance measures were computed per company for each of the four years, namely three accounting rates of return (ROA, ROE and return on sales [ROS]), share returns (dividends and changes in share price), EVA and MVA. All six measures correlated positively with share returns. EVA correlated slightly better with the share returns than the other measures did.Lehn and Makhijas findings regarding EVA, MVA and CEO turnover revealed that the CEOs of companies with high EVAs and MVAs had much lower rates of dismissal than CEOs responsible for low EVAs and MVAs. As expected, a strong inverse relationship was found between share prices and CEO turnover. The CEO turnover rate for companies with share returns above the median was 9.6%, compared to a 19% turnover for companies with share returns below the median. In their study of the relationship between EVA, MVA and corporate focus, Lehn and Makhija (1996:36) distinguished between companies that focus on their core business and ones that diversify and become conglomerates in the hope of exploiting economies of scale. Their research showed that companies with an above median focus earn an average share return of 31.2%. Firms with a below median focus earn 25%. These findings prove that a greater focus on business activities leads to higher levels of EVA and MVA. Lehn and Makhija (1996:36) have concluded that EVA and MVA are effective performance measures that contain information about the quality of strategic decisions and that serve as signals of strategic change.

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OByrnes findings on EVAs link to market value and investor expectations OByrne (1996:119) used nine years of data (for the period from 1985 to 1993) for companies in the 1993 Stern Stewart Performance 1000 to test the explanatory power of capitalized EVA (which is EVA divided by the cost of capital), net operating profit after tax (NOPAT), and free cash flows (FCFs) relative to market value divided by IC. His initial findings showed that FCF explained 0% of the change in the market value divided by the capital ratio, while the r2 was 33% for NOPAT and 31% for EVA. It looked as if NOPAT and EVA had almost the same explanatory power. Two adjustments were made to the original model of Stern and Stewart. The first adjustment allowed for the fact that the EVA multiples were bigger for companies with a positive EVA than the EVA multiples for companies with a negative EVA. The second adjustment allowed for different capital multiples for different capital sizes, in other words, a bigger multiple was used for companies with more invested capital. This adjusted model showed that EVA explained 31% of the variance in market values, compared to the 17% explained by NOPAT. After making a further adjustment, by analysing the changes in the variables, changes in EVA explained 55% of the five-year changes in market value, compared to 33% explained by NOPAT. The corresponding figures for ten-year changes in market value were 74% explained by changes in EVA, compared to 63% explained by NOPAT. OByrne (1996:119) concluded that EVA, unlike NOPAT or other earnings measures, is systematically linked to the market value and that EVA is a powerful tool for understanding the investor expectations that are built into a companys current share price.

Uyemura et al. EVA and wealth creation Uyemura et al. (1996:98) used a sample of the 100 largest US banks for the ten-year period from 1986 to 1995 to calculate MVA and to test the correlation with EVA, as well as four other

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accounting measures, namely net income (amount), EPS, ROE and ROA. The results of their regression analysis are set out in Table 2.

Table 2 Correlation of different performance measures with shareholder wealth Performance measure EVA ROA ROE Net income (amount) EPS R2 40% 13% 10% 8% 6%

Source: Uyemura et al. (1996:98)

The analysis above clearly shows that EVA is the measure that correlates the best by far with shareholder wealth creation. In an alternative approach where changes in the performance measures were regressed against standardised MVA, the results were not very different. Standardised EVA (EVA divided by capital) again had an r2 of 40%, while for ROA it was 25%, for ROE it was 21%, for net income it was 3% and for EPS it was 6%. Grants analysis of relative EVA and relative capital invested Grant (1996:44, 1997:39) studied the relationship between MVA divided by capital and EVA divided by capital for 983 companies selected from the Stern Stewart Performance 1000 for 1993 and 1994. The results for 1993 showed an overall r2 of 32% for all the companies. For the 50 largest US wealth creators, the r2 was 83%. For the 50 biggest US wealth destroyers, it was only 3%. When the same tests were repeated for 1994, they showed that the r2 was 74% for the 50 largest wealth creators and 8% for the 50 largest wealth destroyers. This is in line with the findings of other researchers. These findings revealed a high level of correlation between MVA

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and EVA for companies with a positive EVA, but low levels of correlation for companies with a negative EVA. Grant (1996) found that the real corporate profits should be measured relative to the amount of capital needed to generate that level of profitability. This insight led him to use standardized values for EVA and market value, instead of absolute values. He concluded that his empirical results indicate that EVA has a significant impact on a companys MVA. The value of a company responds to variations in both the near-term EVA outlook and movements in the long-term EVA growth rate.

Milunovich and Tsueis study on the use of EVA and MVA in the US computer industry Milunovich and Tsuei (1996:111) investigated the correlation between frequently used financial measures (including EVA) and the MVA of companies in the US computer technology industry (so-called server-vendors) for the period from 1990 to 1995. The results of their study are set out in Table 3. Table 3 Correlation of different performance measures with MVA in the US computer technology industry Performance measure EVA EPS growth ROE Free growth FCF cash r2 42% 34% 29% 25% 18%

Source: Milunovich and Tsuei (1996:111)

Clearly EVA demonstrated the best correlation and it would be fair to infer that a company that can consistently improve its EVA should be able to boost its MVA and therefore its shareholder
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value. Milunovich and Tsuei (1996:111) argue that the relatively weak correlation between MVA and FCF is due to the fact that FCF can be a misleading indicator. They point out that a fast-growing technology start-up company with positive EVA investment opportunities and a loss-making company on the verge of bankruptcy can have similar negative cash flows. They concluded that growth in earnings is not enough to create value, unless returns are above the cost of capital. They are of the opinion that EVA works best as a supplement to other measures when one is evaluating shares and that EVA sometimes works when other measures fail. Measuring shareholder value Value-based performance measurement: Performance measurement is the method of assessing a companys progress towards achieving its preset goals. Through key performance measures, an organisations strategy is linked to its operations. The objective of performance measurement and management is to increase the shareholder value, profitability, growth, competitiveness, quality, customer satisfaction, etc. of an organisation resulting in improved performance (Moncla & Arents-Gregory 2003). An important concept in performance measurement is benchmarking. Benchmarking is the systematic process of searching for the best business practices, innovative ideas and effective operating procedures to fuel progress and improvement (Bogan&English 1994,p.1). Benchmarking enables companies to compare their key performance measures internally or externally. An organisation can study practices and measure performance from within itself, or against its industry peers. Benchmarking helps organisations refine their strategy through the re-examination of products, prices, practices, strategies, structures and services against competitors and other industry leaders (Bogan & English 1994,p.9).

A particular category of performance measures are financial performance measures. Financial measures indicate to top-management whether their strategy execution is leading to better bottom-line results (Niven 2003, p.19). The financial metrics are based on information obtained from balance sheets, income statements and cashflow statements (Bogan & English 1994, p. 57). Some examples of these metrics are revenue, gross profit, operating income, net income, earnings per share, long-term debt, cash flow, debt/equity ration, etc. By adopting a

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performance measurement system based on financial measures, companies can identify the key performance metrics that would result in improved financial outcomes. As customers place an increasing demand on companies to provide value-added services, it is becoming vital for companies to be able to measure the value of these services in order to justify a premium price for the services and ensure continued profitability (Lambert & Burduroglu 2000). Many organisations have adopted a new breed of performance measure that are based on shareholder value, known as value-based management. Shareholder value is the financial value created for shareholders by the companies in which they invest (Christopher&Ryals 1999, p. 2).Ashareholder is any holder of one or more shares in a company. The evidence of being a shareholder is in the form of a stock certificate. The shareholder value theory states that a company creates this value when it meets or exceeds a cost of capital that suitably reflects its investment risk (Lambert & Burduroglu 2000, p. 10). Companies are choosing to employ a system of measuring shareholder value for many reasons (Copeland et al 1994, p. 22). First, value is the best metric of performance as it is the only measure that is comprehensive and hence is useful for decision-making. By increasing shareholder value, companies can maximize the value for other stakeholders (customers, labour and government (through taxes paid) and suppliers of capital). Second, shareholders are the only stakeholders of a company who simultaneously maximize everyones claim in seeking to maximize their own. Finally, companies that are unable to create shareholder value will find that capital flows away from them and towards their competitors who are creating shareholder value. The most common methods for measuring shareholder value are (Lambert & Burduroglu 2000, p. 2): Customer satisfaction and customer value-added (CVA) Total cost analysis Profitability analysis Strategic profit model (SPM) Economic value-added (EVA)

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Economic value-added (EVA) Stern Stewart & Co (www.sternstewart.com/) created the EVA to aid managers in their decision-making by incorporating two basic concepts of finance. The first is that the objective of any business is to maximize the value created for the companys shareholders. Second, the value of a company is dependent on the extent to which shareholders expect earnings to be greater than or less than the cost of capital. A continuous increase in EVA will result in an increase in the market value of the company. EVA has been adopted by many companies including Coca Cola Inc, DuPont, AT&T, Quaker Oats and General Motors. In a Stern Stewart Research Special Report (Stewart et al 2002), companies that implemented the EVA in the 1990s outperformed their peers by an average of 8_3% per annum over the five years following its adoption, and created total excess shareholder wealth of $116 billion. The report also showed that even in periods of economic slowdown, EVA clients earned a total return of 36_5% and beat the S&P 500 by a total of 69_8%. The reason so many companies have adopted the EVA and have realized financial benefits are due to the advantages of its use. EVA highlights the areas of the company that create value. This enables managers to take decisions on increasing the efficiency of their capital and operations by focusing work on areas with higher productivity. EVA-based financial management gives managers superior information, motivation, empowerment and accountability to ensure that their decisions create the greatest amount of shareholder value. EVA aligns the decisions managers take with the creation of shareholder wealth. EVA is the net operating profit after tax (NOPAT) minus the capital charge of a company. The NOPAT of a company is defined as the operating profit after taxes have been deducted. It is the return on the companys total capital invested. The capital charge is an appropriate charge for the opportunity cost of all capital invested in a company. EVA shows the dollar amount of wealth a company has created or destroyed. The information required to calculate a companys EVA is obtained from a companys income statement and balance sheet. Table 1shows how to calculate a companys EVA. Figure 2 shows how the above steps lead to

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the calculation of the EVA of a company. The significant components of a companys capital (C) are the working capital, the fixed assets and the intangible assets (e.g. goodwill and patents). The companys working capital is difference of the total current assets and the current liabilities. The current assets include the companys accounts receivables, inventory, prepaid expenses, cash and other current assets. The current liabilities is the sum of accounts payable, notes payable and accrued liabilities, less short-term debt. A company can increase its EVA in the following ways. -Increasing NOPAT by increasing operating income -Reducing the capital charge by reducing the companys capital and cost of capital

EVA is also shareholder-centric and hence of little relevance to the rest of the stake holders. EVA is identical to residual income, which was largely abandoned by US companies years ago (Keys, Azamhuzjaev, and Mackey, 2001).

Value-based management (VBM) has been referred to as the fastest and hottest ticket to shareholder wealth. Incorporating such techniques as economic value added (EVA), return on operating invested capital (ROIC), and market value added (MVA), VBM is a complete financial management and incentive compensation system that guides decision-making at every level. Adopting companies use VBM as a guide in financial planning, monitoring, and controlling operations. This article illustrates the computation of EVA, ROIC, and MVA for Toll Brothers, Inc., a company in the home-building industry, which is generally characterized as having a high volatility of investment needs. The company is of average size for the industry, with a market capitalization of $1,742 million. Typical of the industry, the company exhibits relatively sporadic growth, but has maintained an average annual revenue growth of 18% over the last five years.

A method of performance evaluation that adjusts accounting performance for investors' required return on investment. Suppose a division produces a 12% return on capital invested. Given the risk of the division's business line, if investors would usually require 14% on capital invested for this level of risk, the division destroyed shareholder value by the EVA metric. This SternStewart has a trade mark on this term.

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Economic Value Added: Theory, Evidence, A Missing Link. by Ray, Russ Review of Business Spring, 2001 Evidence is mixed regarding the efficacy of Economic Value Added (EVA), the relatively new financial-management tool. This analysis offers a new definition of value, and suggests that the missing link in the EVA process is productivity, generally found to be the engine of all economic growth. Introduction In recent years, Economic Value Added has been touted by the popular press as the financial savior of the corporate world. Indeed, Fortune magazine -- in a 1993 cover story -- described EVA as "today's hottest financial idea and getting hotter." Corporate giants such as Coca-Cola, AT&T, Briggs-Stratton, DuPont, Eli Lilly, Quaker Oats, and others have adopted this new financial tool and, in many instances, reported significantly improved financials. A good example of EVA involving Coca-Cola and General Motors is presented in [4]. Coca-Cola, one of the earliest users of EVA, saw its stock price increase from $3 (on a split-adjusted basis) in 1981, when Coke first adopted EVA, to over $60. Moreover, its Market Value Added (MVA), calculated as the market value of all stock outstanding less its book value, increased by a factor of ten. Coke's EVA experience seemingly contrasts sharply with the experience of some other firms not employing EVA, notably General Motors. By 1995, before the U.S. bull market significantly inflated stock prices, the market value of GM's stock was $69 billion. However, up to that year, investors had cumulatively supplied GM with $87 billion of equity, so GM was actually destroying capital as it manufactured cars.

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In terms of stock price, GM's shareholders received only $.79 of wealth for every $1.00 they had cumulatively invested in GM, as of 1995. In sharp contrast, Coca-Cola's investors received $8.63 in wealth for every dollar invested by 1995. If the bull market of the 1990's is factored in, GM's investors have finally broken even, while Coca-Cola's investors have realized even greater returns. On the surface, EVA is seemingly a powerful new financial management tool which is being used successfully and increasingly by some of our "best" corporations. However, when the empirical surface is scratched, EVA doesn't seem to be quite the elixir purported by its proponents. Indeed, EVA may be nothing more than a clever (and lucrative) re-packaging of some very old business principles. This article reviews the theory and evidence regarding EVA, and places EVA within the larger context of valuation metrics. The analysis attempts to resolve the conflicting studies regarding EVA by offering a new hypothesis, viz., that the missing link between EVA and improved financials is actually productivity, incrementally aided by a well-documented measurement effect. The following section defines value in such a way that the importance of productivity can be later identified. The section thereafter places EVA within the larger context of valuation metrics. Subsequent sections review the literature and suggest that the ongoing empirical dispute about EVA can be resolved by recognizing productivity (aided by a "measurement effect") as the missing link between EVA and better financials. What is "Value"? It may be helpful to begin this discussion by defining its core term. Value is simply the quality/price which is perceived/paid by the customer. The quality component of value includes the inherent quality of the particular product or service, as well as all of its auxiliary features (follow-up service, complaint resolution, etc.). From the viewpoint of the customer, the price of the product or service must at least be commensurate with - or, ideally, commensurately lower than - the perceived value of the product or service received, or else the customer will feel that he or she has not received real value from the

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exchange. In the long run, if a firm's customers perceive that they're not receiving value, then the firm will almost certainly become just another corporate fatality (assuming free markets, of course). Valuation Metrics In any discussion of value added, the key question becomes, How is value measured? Valuation metrics - the empirical measuring of value added - include accounting value, economic value, net present value, and, now, Economic Value Added. Accounting value essentially measures the value added by a firm as the change in the firm's earnings. Although a relatively precise measure, accounting value suffers from some well-known deficiencies. First, accounting earnings net out non-cash expenses, and are thus not a true measure of the actual cash earnings generated by a firm. Secondly, accounting metrics ignore the returns required by shareholders. (Obviously, a million dollar accounting profit would be grossly inadequate if it required a trillion dollars of shareholders' money to accomplish the result.) Finally, accounting metrics tend to be single-period measures, which can always be maximized by ignoring the long run health of the firm (e.g., by delaying or avoiding routine maintenance). The second measure utilized in valuation metrics is economic value, which is residual income left over after all suppliers of capital have been adequately compensated for the risk they've incurred. Although a superior metric than accounting value, economic value is difficult to measure, primarily because hard to ascertain. Besides, it, too, is a single period metric. Net present value (NPV) overcomes the drawbacks of both accounting and economic metrics. In addition to measuring incremental cash flows (the real income occurring to a firm from a particular project) over a multi-period time frame, it also considers the returns required by all suppliers of capital, as imbedded in the Weighted Average Cost of Capital (WACC), and as adjusted on an aftertax basis. Not surprisingly, NPV has been extensively (and successfully) utilized for decades as the preeminent decision rule in project adoption. EVA The newest evaluation metric is Economic Value Added, commonly referred to as "EVA," which is a registered trademark of Stern Stewart & Company, the New York consulting firm which

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developed this tool. In its essence, EVA is Net Operating Profit After taxes (NOPAT) less the dollar cost of the capital required to create that profit. The idea is not new: the return on any given increment of capital must be greater than the cost of that capital. Indeed, the capital budgeting tool of internal rate of return has embodied this principle for many decades. However, the EVA measurement process departs (sometimes considerably) from conventional accounting standards; and, in fact, Stern Stewart & Company utilize 164 variations (at last count) of their metric, depending upon the peculiarities of the particular firm they're advising. Some of these applications are at significant variance with Generally Accepted Accounting Principles (GAAP), such as the capitalization of R&D and advertising. In its simplest form: [EVA.sub.t] =[r.sub.t] - [K.sub.t])[C.sub.t-1] (1) where [r.sub.t] is the firm's return on capital at time t, i.e., [r.sub.t] = [NOPAT.sub.t] / [C.sub.t-1] (2) [k.sub.t] is the firm's WACC at time t, and [C.sub.t-1] is the firm's (or division's, or department's...) capital at the beginning of the period. Since its inception, EVA has received a lot of very favorable press. Indeed, such prestigious publications as Fortune, Investor's Business Daily, CFO, Financial Executive, Management Review, Chief Executive, and the Wall Street Journal have touted its virtues. Needless to say, the principals of Stern Stewart have been well remunerated in the process. Critics of EVA argue that it is nothing more than NPV re-packaged at departmental, divisional, and firm-wide levels. They argue that Stern Stewart & Company's only real contribution to the capital budgeting and incentive compensation process is the development of (arguably, arbitrary) measures with which to implement NPV on scales larger than a project basis. Such measures include capitalizing advertising, R&D and certain other expenses in order to ascertain the exact capital base being utilized (the denominator in equation (2)). After identifying the capital base, the firm is then able to use NOPAT to find its return on capital and, ultimately, its EVA.

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The evidence in favor of EVA is mainly (but not entirely) anecdotal. One study [7] reports 250 firms currently, and satisfactorily, using EVA For such firms, some researchers [1, 2] report very positive ad hoc experiences with EVA On an empirical level, significant correlation between EVA and MVA has been found [13,11]. A positive relationship between EVA and shareholder returns has also been found [9]. The evidence against EVA essentially finds poor statistical relationships between EVA and various financial measures. Some researchers [3] find little relationship between EVA and MVA (and, hence, stock price), while others [101 find statistically poor relationships between EVA and shareholder returns. Other studies [6] report that "the market seems more focused on 'profit' than EVA." In summary, the evidence is mixed, as so often happens when new techniques, new theories, and new processes are introduced. (For a more comprehensive review of this conflicting evidence, see [5].) So far, however, neither body of evidence seems to significantly outweigh the other. This study seeks to resolve this controversy by suggesting that the missing link in the EVA process is productivity, a factor which has so far been ignored by both the proponents and the critics of EVA. This article argues that EVA is simply a measuring tool (albeit, if used correctly, a powerful one), which points out where value is being created by the firm, and where it's not. In other words, EVA does not create value -- it simply measures it. What the firm does with this measure - it might even choose to ignore it - is a totally separate matter; in a rational market, maximizing EVA should maximize the firm's share price and, hence, shareholder wealth. The real reason why a firm's financials might improve after EVA adoption is twofold: 1) the measurement effect; and, 2) productivity increases - the real missing link between EVA and better financials. The Fishbowl Factor So what is the "measurement effect"? As common sense would suggest, and as numerous studies have confirmed, the quantity and quality of employees' output increase when these same employees know that their output is being measured. After all, almost all of us perform better when we know we're in the limelight (or, more precisely, a limelighted fish bowl), and especially when we know that our livelihoods are at stake. This is simply human nature.

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As applied to EVA, this self-fulfilling effect means that every person in the firm knows that they are being held accountable for every dollar allotted to them. Moreover, each person also knows that they are expected to turn that dollar into something greater than a dollar - say, $1.15. If this transformation doesn't take place, the employee will soon realize another age-old principle: no ticket, no laundry. As might be expected, EVA thus spurs people to get their corporate act together, and soon. Not surprisingly, this "survival incentive" causes greater value to be created for the customer. EVA and Productivity The second (and predominant) factor at play in the EVA process is the driving force behind all economic growth - productivity. In the long run, productivity is the driving force behind success at every level: national, industry, firm, division, department, and even at the individual level (holding, of course, political factors constant). At the national level, countries with powerful productivities continually enjoy rising standards of living and greater productive capacities (witness, in particular, the U.S. with its technology-driven productivity increases of recent years). At the corporate level, productive firms generally realize rising share prices and, in fact, improved performances in all of their financials (profits, cash flow, stock prices, etc.). Doubters of this productivity premise are referred to a watershed 1993 study by the U.S. Department of Labor, "High Performance Work Practices and Firm Performance." The study is essentially a massive review of the literature on productivity, which is found to be the ultimate driving force behind real economic growth and better financials. Probably the best way to see the relationship between EVA and productivity is to distill the EVA measuring tool down to its essence by reformulating equation (1) to the general expression: EVA = (r-k) capital (3) where r is, again, the firm's return on its capital (the sum total of all assets being employed), and k is the (weighted-average) cost of that capital. As many frustrated CFO's can attest, the firm's cost of capital is, more or less, determined by market forces (and, in particular, by how the market perceives the firm's riskiness). Conceivably, the firm

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could lower its cost of capital by mixing in more debt, but this creates more risk for shareholders, and it also removes the firm from its optimal capital structure (where, presumably, it was operating in the first place). Thus, the firm's capital cost is largely determined by outside forces, and is essentially a given over which the firm has little control. Algebra aficionados might point out, especially after seeing equation (2) presented previously, that reducing capital is another way to increase EVA, but this presumes that the firm is inefficient, i.e., using more capital than it needs to achieve any given outcome. If this is the case, then the potential for improvement exists in many areas by simply requiring the same output with less capital. (And some firms, such as CSX, have used EVA to effect such requirements.) This analysis focuses on firms which are already reasonably efficient. As an anonymous referee has pointed out, a firm could increase its return on capital (and, hence, its EVA) by understating its assets. Such manipulation should, except for an occasional instance, be minimal if scrupulous auditors require the firm to consistently employ Generally Accepted Accounting Principles. Moreover, as this same referee also pointed out, depreciation can affect a firm's EVA-return on capital. In general, accelerated depreciation (chosen almost universally by firms in order to minimize taxes), would tend to understate (relative to straight-line depreciation) the EVA returns on capital, since the impact would have a greater percentage-change effect upon the numerator in equation (2) than upon the denominator. However, this understatement will be uniform and consistent, so that it is not significant for EVA decision-making purposes. If the cost of capital is a given, then obviously the only way for a reasonably efficient firm to increase its EVA is to increase its return on capital. So now the million-dollar question becomes, "How does a firm increase its return on capital"? The award-winning answer: primarily, by increasing its productivity.

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What is Productivity? Productivity is a funny animal. First, it must be matched to consumer demand. A firm could be the most productive ever at manufacturing buggy whips, but its long-run health would be doubtful, to say the least. On the other hand, a firm could be embarrassingly non-productive, but if it has a newly patented cure for cancer or AIDS, then it'll be a financial success, regardless. In general, the greater the consumer demand, the lower the productivity required for any given financial outcome, and vice versa. Assuming the firm focuses on some sustainable demand, then what causes productivity to increase? It's a long shopping list, and includes: innovation (the creation of something new), technology (the application of innovation), human capital investment (screening, training, and compensation), and myriad other factors. In general, these factors -- especially innovation and technology -- combine to accomplish one or more of four outcomes: 1) increased output per work-hour; 2) increased quality; 3) decreased costs; or 4) decreased error/defects. Any of these four outcomes is, by definition, an increase in the firm's productivity. Productivity vs. EVA And herein lies the gist of this whole argument. Any of these four productivity outcomes alters the quality/price which is perceived/paid by the customer, thus creating greater value for the customer. An increase in the quality of the product or service, or a decrease in its defects (which is tantamount to an increase in quality) obviously increases the numerator of the quality/price ratio. In this same context, the price of the firm's product or service will decrease due to a decrease in the firm's cost, a decrease in its error rate (which leads to a decrease in its costs), or an increase in its output per work-hour. Free-market competition will, over time, cause any or all of these cost reductions to be passed on (at least partially) to the consumer in the form of lower prices. In either case, an increase in quality or a decrease in price, productivity causes more value to be created for the customer. When rational and informed investors see this increase in value added,

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they'll naturally bid up the price of the stock as they scurry to buy slices of the greater profits generated by this bigger-and-better value pie. From the firm's perspective, EVA is an internal financial tool which holds every manager in the firm accountable for every dollar allotted to them. From the market's perspective, EVA is a very useful tool with which the firm can maximize the value of the firm. Hence, EVA and productivity are vitally and inseparably linked, one to the other. Adopting the EVA measuring tool allows firms to see where value is being created, and where it's not. In general, the firm will find that value is being created wherever productivity (linked to demand) has pushed the firm's return on capital past its cost of capital. (Moreover, as discussed earlier, some additional increment of value will be created by the "measurement effect.") Thereafter, marginal increases in value added can be attained by either decreasing the firm's cost of capital (hard to do, since it's largely market determined), or by increasing its productivity (the never-ending struggle for any firm competing in a free market).

Comparison with other approaches

Other approaches along similar lines include Residual Income (RI) and Residual Cash Flow. Although EVA is similar to Residual Income, under some definitions there may be minor technical differences between EVA and RI (for example, adjustments that might be made to NOPAT before it is suitable for the formula below). Residual Cash Flow is another, much older term for economic profit. In all three cases, money cost of capital refers to the amount of money rather than the proportional cost (% cost of capital); at the same time, the adjustments to NOPAT are unique to EVA. Although in concept, these approaches are in a sense nothing more than the traditional, commonsense idea of "profit", the utility of having a separate and more precisely defined term such as EVA is that it makes a clear separation from dubious accounting adjustments that have enabled businesses such as Enron to report profits while actually approaching insolvency. Other measures of shareholder value include:

Added Value Market value added Total Shareholder Return

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Abstract
This paper measures property companies performance under new economic performance metric known as Economic Value Added (EVA) and identifies which companies perform better. The EVA of 27 Malaysia property companies are computed and analysed during the periods of 1997 through 2006. The EVA is an economic performance metric proposed by Stern Stewart Management Services. It claims to have successfully eliminated financial and accounting distortions and provides a true measure of a companys success in driving shareholder value. Overall, the result of the present study shows that most property companies in Malaysia fail to generate enough income to cover their cost of capital, and thus indicating failure in creating corporate wealth. In order to have positive EVA in the future, firms must improved their strategic and scenario planning. In realizing this, management should focus more on investing capital in the high return projects and at the same time improving on optimal capital structure. Literally, EVA is the quantum of economic value (or profits) generated by a company in excess of its Cost Of Capital (COC). Mathematically, it is the difference between the Net Operating Profits After Taxes (NOPAT) and the capital charge; or, the product of the capital employed and the difference between the Return On Capital Employed (ROCE) and the COC. In principle, it is a comprehensive financial management system that encompasses a range of functions like capital budgeting, acquisition pricing, goal-setting, and strategic planning. In accounting terms, the concept of EVA is based on the principle of residual income, which states that the real income generated by a company is the residue that remains after a company's shareholders and debtors have been paid their annual required return. However, even traditional accounting is based on the residual income principle: the Profits After Tax (pat) is the residual income after the payment of interest and dividend. Where the technique of EVA scores over the plain-vanilla residual income method is in its ability to identify the contribution of every unit of a company's output to, and its impact on, the total economic value of the company. The logical extension EVA can be used to evaluate the contribution of individual products, employees and departments. No longer will managers and workers be forced to focus on tracking unidimensional local optima for want of a better measure. The Coca-Cola Co., for instance, measures EVA at the level of each bottle (or can) of beverage it sells. Explains Anil Sachdev, 45, Managing Director, Eicher Consultancy Services: ''The concept of residual income has been around for years, but EVA is a significant improvement over it. It has taken the best of the residual income concept, and eliminated the worst of accounting practices.'' And emerged as a reliable performance metric. EVAs effective deal with accounting anomalies A measure is only as reliable as the components on which it is based. Garbage in; garbage out. The EVA methodology sanitises the financial information it uses. Stern Stewart lists 168

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accounting adjustments-including the amortisation of goodwill, R&D expenditure, interest payments, and non-interest bearing current liabilities-which are an integral part of this sanitisation process. The objective is to ensure that the accounting numbers used by a company in the EVA process are real, or economic figures, and not notional ones. A company needs to fix these anomalies if it wishes its implementation of EVA to be effective. Avers Chaith Kondragunta, 29, Vice-President and India Head, Stern Stewart & Co.: ''These adjustments segregate the financial information and convert the accounting framework into the EVA framework so as to reflect the right value creation, motivate the right behaviour, and produce consistent and definitive results.'' However, the number of adjustments that a company will have to make is not as high as 168: the typical company will need to make only between 6 and 11 adjustments. EVA is superior to other measures of financial and corporate performance Traditional measures of corporate performance assume that there is no charge on equity. The logic? Dividends come out of profits, and if a company does not make a profit, it can skip paying out dividends. Thus, shareholder-funds are available for free. Assumptions like these constitute a recipe for disaster. Shareholders expect at least a market rate of return when they buy a company's shares. Second, traditional measures of corporate performance argue that since a company's pat is, in some way, meant for its shareholders (part of it is doled out as dividend, and the rest is retained to fund future growth), they are comprehensive measures of corporate performance. However, these measures encourage the company's managers to take decisions that will boost the bottomline. The first liabilities are likely to be costs related to R&D and market development, which do not result in an immediate increase in pat. This approach will inhibit growth and, eventually, destroy shareholder value. In contrast, the EVA process requires that expenses like R&D and market development be capitalised over a 5-year period. Points out Mangesh G. Korgaonker, 53, ICICI Chair Professor and Head, School of Management, Indian Institute of Technology, Mumbai: ''EVA has standardised the financial accounting process independent of the balance-sheet approach. It is a potent financial tool for the continued economic growth of an organisation and all its constituents.'' This approach ensures that growth isn't sacrificed at the altar of short-term results. Indeed, EVA was created by Joel Stern and Bennet Stewart in the wake of the reckless spree of diversification that most large companies in the US and Europe embarked on in the late 1970s and early 1980s. The basis of diversification is a company's , often mistaken, belief that it can invest funds far more efficiently than the market. Its very architecture ensured that EVA promoted the creation of shareholder value, and not growth that came at the expense of shareholder funds. To align managerial initiative with shareholder expectations, Stern Stewart linked EVA to managerial incentives. Even today, the company believes that the very essence of getting managers to do what is best for the shareholders is to not just offer stock-options, but to create a

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deferred incentives-account. The amount in the account increases if the company manages to add incremental EVA, and decreases if it doesn't. And the incentives themselves are disbursed at the end of a pre-ordained time-period. But is EVA a superior measure of corporate performance than higher-order balance-sheetoriented tools like Return On Net Worth (RONW), Return On Equity (roe), or Return On Total Assets (ROTA)? Actually, yes. A company's RONW is a function of the returns its products and projects manage to generate. The catch? Whether this rate is lower or higher than the company's cost of capital is irrelevant. A company's EVA, however, will increase only if its products and projects generate a rate of return higher than its cost of capital. Even ROTA isn't as refined as EVA, since it encourages companies to enter product-markets that can boost their sales, and, consequently, profits. Concurs Ralph Heuwing, 33, VicePresident and Director, The Boston Consulting Group: ''EVA is like a corporate nervous system. It enables the organisation to evaluate its decisions through a strategic lens.'' It is, perhaps, its ability to serve as a critical part of the strategy-process that makes EVA a thoroughbred metric. The pivotal goal of an organisation is to add shareholder value; and EVA is an accurate measure of the incremental annual shareholder value generated by a company. By using EVA to evaluate options, a company will choose the strategy that results in the maximum addition of shareholder value. For instance, logistics-major Ryder Systems bases its pricing decisions on EVA. Lafarge, the French cement transnational, uses EVA as part of the due-diligence process while acquiring other companies. All this makes EVA an ideal tool for equity analysis: the HSBC Group, for instance, bases its analysis of companies on EVA. Explains Vasudeo Joshi, 35, Director and Head of Research, HSBC India Securities: ''Since EVA standardises financial information, it provides a common platform for us to compare various companies across the globe.'' Goldman Sachs and Credit Suisse First Boston have instructed their analysts to use EVA while analysing a company. And the US-based Oppenheimer Capital only invests in those companies that use EVA. Implementation of EVA A lot, as indicated by the fact that companies don't use EVA; they implement it. An EVAcompany, therefore, is a company that is managed the EVA way. What does this involve? One, the primary objective of the company is the enhancement of EVA. Not sales; not profits; but EVA. The mathematical construct of EVA ensures that those companies trying to optimise it end up optimising sales revenues, COC, ROCE, and Net Operating Profits. Two, the entire financial reporting of the company is based on the EVA methodology. This bestows the financial statements of the company with a dash of reality. Three, EVA is the moving force behind the company's existing and new projects. Put simply, to justify their acts, every individual and department in the company should look, not at its impact on EPS, the p-e ratio, or RONW, but on its impact on EVA. Thus, EVA-companies pursue a course of action only if it results in an incremental EVA. And their managers focus on optimising the COC, inventory, and accounts receivable. Implementing EVA is a 4-step process. Stern-Stewart calls

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this the 4m process. The 4 ms are: Measurement, Management System, Motivation, and Mindset. MEASUREMENT. Any company that wishes to implement EVA should institutionalise the process of measuring the metric, regularly. This measurement should be carried out after carrying out the prescribed accounting adjustments, using the formula EVA = (ROCE - COC) x Capital Employed. MANAGEMENT SYSTEM. The company should be willing to align its management system to the EVA process. The EVA-based management system is the basis on which the company should take decisions related to the choice of strategy, capital allocation, M&As, divesting businesses, and goal-setting. In effect, each one of a company's activities should be aligned to, and derived from the company's EVA process. MOTIVATION. Companies should decide to implement EVA only if they are prepared to implement the incentive-plan that goes with it. This plan ensures that the only way in which managers can earn a higher bonus is by creating more value for shareholders. Sales-based incentives reward managers for incremental sales without considering the costs involved, and profits-based reward systems can be the source of resentment, at least among those managers who believe their rewards are based on variables beyond their control. An EVA-based incentive system, however, encourages managers to operate in such a way as to maximise the EVA, not just of the operation they oversee, but of the company as a whole. Thus, it aims to make every employee of an organisation an entrepreneur who seeks not just to perform his of her function well, but to do so in a way that will enhance the EVA of the company. MINDSET. Like other transformation techniques, the effective implementation of EVA necessitates a change in the culture and mindset of the company. All constituents of the organisation need to be taught to focus on one objective: maximising EVA. Any company that manages to do this will find all its employees speaking the same language. Indeed, EVA is an ideal tool to bring about a transformation in a company's culture. Its singular focus leaves no room for ambiguity: it isn't difficult for employees to know just what actions of theirs will create EVA, and what will destroy it. It does not take long to implement EVA. A typical company can do it in between 3 and 8 months. But companies like Sony and Siemens, which propose to implement EVA across locations, will find that the process takes 18 to 30 months. However, EVA offers the flexibility of starting small to the large, multi-divisional, and multi-location corporation: it can be implemented in one division as a precursor to a company-wide rollout. The key to the successful implementation of EVA lies in integrating it into the company's incentive-plan. Agrees Milind Sarwate, 39, CFO, Marico Industries, which has been measuring its EVA for the last 3-4 years, but now plans to take the logical next-step by setting up a EVAbased performance-measurement system: ''Institutionalising EVA is not easy. But it can best be achieved by using EVA as the variable in the company's performance-appraisal or the flexi-pay process.'' EVA lends itself to this: it can be measured at the level of each of a company's activities.

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This also removes the fundamental flaw in most traditional compensation models. The compensation of the majority of a company's employees is fixed. The quantum of this compensation is a function of the employee's ability to perform his or her assigned role. All too often, this translates into doing what one does better, or doing more of what one does irrespective of whether that adds value to the company as a whole. An EVA-linked variablecompensation model ensures that employees focus their efforts on activities that enhance the company's economic value. From these principles emerges a simple 4-step process that companies can use to implement EVA. The first requires the company implementing EVA to train as many managers as it deems necessary-this depends on whether the company wishes to implement EVA in one of its divisions or across the organisation-in the theory of EVA. Second, the company should put in place a system-this could be part of either the organisation's MIS or its ERP-that makes it easy for managers to derive the information they need to calculate EVA, from the company's financial reporting system. Three, companies adopting EVA should develop the culture of entrepreneurship among their employees. In most companies, managers focus on performing the tasks earmarked for them well; in EVA-companies, they have the responsibility of ensuring that their performance translates into an increase in the organisation's ability to add shareholder value. The fourth step is to align the organisation's internal processes-its management, performance-appraisal, and compensation systems-to its ultimate objective of increasing shareholder value. This is the most important stage in the EVA-implementation process: in its absence, managers will not have the requisite motivation to look beyond the comfort of local, and short-term optima. EVA is an annual measure and it does not encourage an emphasis on the short term A standard allegation against EVA is that the excessive focus on ROCE and COC constrains capital growth and promotes short-termism. True, EVA is an annual measure: it is the difference between the company's NOPAT and its capital charge, in one financial year. Thus, argue some of EVA's staunchest critics, it encourages managers to postpone or ignore capital investments that do not generate immediate returns. This, they posit, helps boost the company's ROCE in the short-term. Counters Joel Stern, 58, Managing Partner, Stern Stewart & Co.: ''The EVA system puts the brakes on growth only when it is a non-profitable. Experience shows that our clients grow faster than their peers. In fact, EVA promotes growth in 2 ways. First, it holds managers accountable for the long term by putting a portion of their bonuses at risk if there is a subsequent decrease in the company's EVA. Equally important, because bonuses are based on changes in EVA, the only way that managers can continually earn large bonuses is by finding ways to profitably grow the business. This is better for shareholders than rewarding managers for any growth regardless of whether it provides returns vis--vis the COC.'' In effect, EVA encourages managers to invest in growth, but only if it is growth that can generate returns in the long term. The financial advisory also argues that the real measure of a company's long-term ability to add shareholder value is Market Value Added (MVA). In technical terms, MVA is the value added

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by the management to the equity capital and debt entrusted to it by the company's shareholders. Mathematically, the MVA of a company is the Net Present Value (NPV) of all its future EVAs. Thus, any management system that encourages the continuous measurement of EVA and rewards sustained improvement encourages the employees to add shareholder value. If EVA has been around for 18 years, and is everything described here, why have a mere 300 companies across the world, and only NIIT in India, adopted it? One reason could be the accounting-rigour the implementation of EVA demands. Most Indian companies are reluctant to change accounting systems. Notional profits could well disappear when adjustments for accounting anomalies are made. Another, the fact that Stern Stewart insists that the companies it helps implement EVA also implement the EVA-based incentive-compensation or variablecompensation model. Managers are loath to set in motion something that could affect their own earnings. But a company that manages to implement EVA will find that its employees acquire an unrelenting focus on shareholder value. Aligning shareholder-, and employee-interests could well be this wonder-tool's greatest achievement. Welcome back to India, Mr Stern. It is now 18 years since the concept of EVA (Economic Value Added) was originated by Stern Stewart & Co. (SSC). Are you working on any performance- management metric that is fundamentally different from EVA? What can this metric do that EVA can't? A. SSC has not, and does not plan to, develop a new tool. We believe that EVA is a comprehensive financial management system. But there are 2 things that we have worked on. One, we have improved EVA. And two, we have developed special applications for industries with unique characteristics, such as retailing, and exploration- and extraction-intensive industries-including oil and gas, public utilities, banks, and insurance companies. The new generation of EVA tools has been upgraded to include advanced capital budgeting ideas, including the most recent, Real Options, which is of critical importance in high-risk investment areas such as the Net and oil and gas exploration. EVA is a technique that offers an alternative to the traditional accounting way in which corporate performance is measured. The Balanced Scorecard, developed by Harvard Professor Robert Kaplan and Renaissance Consultant David Norton, is another technique that does something similar. Does the Balanced Scorecard have a role to play in EVA-luating a company? There is no reason why companies should not adopt the Balanced Scorecard and EVA at the same time. As Bob Kaplan has said, both EVA and the Balanced Scorecard are the result of shortcomings in the basic concepts of accounting. Accounting fails to include many different vital sources for decision-making that the Balanced Scorecard provides; EVA measures the true economic value of an enterprise that accounting omits. For instance, accounting writes off all intangible assets-including R&D, advertising and promotion, training and development costs for people, and accounting goodwill-in the current year. In contrast, EVA capitalises the entire amount spent under these heads, and writes them

56

off only over their expected economic useful life. The Balanced Scorecard and EVA are highly complementary, and are not in conflict.

Is there a geographical or cultural context to implementing EVA? Is it easy in some countries and cultures and difficult in others? How do you handle these cultural variations?

There is no question that implementing EVA is easiest in the Anglo-Saxon world, where issues related to motivation and rewards encourage a pay-for-performance attitude. However, in parts of the world where this type of culture is absent-France, Germany, and Japan come immediately to mind-implementing EVA can be difficult. However, over the last 5 years, the failure of the Japanese model has encouraged managers to look for a way out, and EVA has made breakthroughs in this cultural environment too. And the THE PERSON acceptance of EVA by companies in South Asia seems to Name: Joel Stern suggest that a properly-designed EVA implementation programme works in Asian cultures. Age: 58 years Education: Graduate in economics and finance from the University of Chicago What are the other variables that have an impact on EVA? For instance, what are the characteristics of a company where EVA DESIGNATIONS: Founder & Managing Partner, Stern can be implemented with the least trouble? And is there a Stewart & Co.; Adjunct particular stage in the organisational life-cycle when EVA works best? Or does it suit one industry-type more than the Professor at the Graduate other? Schools of Business at the Fordham University and the Columbia University, US, as The ideal company to implement EVA is one in which the board well as the University of Witwatersrand, South Africa of directors and the senior management want to improve the POSITIONS HELD: efficiency of a firm, take advantage of opportunities quickly, and align the interests of the management and shareholders. President, Chase Financial However, there is no particular stage in a firm's life-cycle when Policy, the financial advisory EVA can be best applied. It works well in both the introductory arm of Chase Manhattan and growth phases, where companies grow rapidly, as well as in Bank the maturity and decline phases, where some companies seem to lose their way. As for the industry-type, the industry is far less BOOKS AUTHORED: important than the attitude of the management. The management Analytical Methods In Financial Planning; must want the benefits of EVA. This is the key driver of its success. Measuring Corporate Performance EVA is, probably, best calculated at the level of a business unit. INTERESTS: Reading books, However, even in non-diversified businesses, decisions that photography BT INTERVIEWED HIM BECAUSE: He created the 57 true metric of corporate performance: EVA

have a bearing on the unit's profitability are rarely taken at that level. In a diversified business, of course, things are worse. To offer a simple example, how will EVA account for synergies between business units? The goal, of course, is to maximise the EVA of the corporation as a whole, and not of any one business unit. The EVA of the total enterprise, naturally, captures the net impact of a decision on the EVAs of the various units. For this reason, incentives based on the EVA of the total enterprise are the most appropriate at the corporate level. For individual business units, it is, often, best that a portion of all bonuses be based on aggregate EVA to discourage the individual units from pursuing courses that enhance their own EVAs, but detract from the EVA of the whole. SSC also has the expertise to craft proper transfer-pricing solutions that recognise the synergies between business units. The EVA framework we use results in the reduction of friction between units. Is there a new stream of management-thinking emerging where metric-oriented tools, like EVA or ABC, aid a company's strategy process? Strategy, essentially, is a set of choices or decisions. If the impact of a particular decision on the EVA of a company were known, it would be possible to identify decisions that maximise EVA. Does EVA become part of the strategy process in such a case? We like to say that EVA is an agnostic in the area of strategy. That is, it does not dictate one course of strategy or another. However, EVA does have an extremely important role in strategy formation: it is used to assess the likely impact of competing strategies on shareholder wealth, and can help the management select the one that will best serve shareholders. EVA can be particularly effective in this regard when it is augmented by new tools such as Real Options analysis.

How does EVA fit in with the concept of corporate governance? Both, after all, are focused on shareholder value... All companies have some form of corporate governance. The important question is whether a company has an effective governance system, one that properly allocates decision rights and imbues managers and workers with a sense of ownership in the outcome of the decisions they take. EVA bonus systems do this by giving employees an ownership-stake in improvements in the EVA of their divisions or operations. This causes employees to behave like owners, and reduces or eliminates the need for outside interference in decision-making. EVA and EVA-incentives provide this type of internal governance. EVA has the ability to punish a non-performing organisation by failing to reward it. EVA bonus plans are effective because they give managers and workers a stake in improving EVA. If the EVA of the division or operation they are in charge of fails to improve, they receive no reward. Equally important, a portion of exceptional rewards are held back for later payment, and are at risk if EVA fails

58

subsequently. However, the key to wealth-creation is not punishing failure; it is to properly reward success.

The role of intangible assets is critical in today's context. Is the EVA way of dealing with assets like brands and goodwill superior to the accounting way? EVA deals with goodwill by recognising that it is an investment on which managers must earn a minimum rate of return. Accordingly, we keep goodwill on the balance-sheet forever instead of gradually amortising it, as accountants do. In the case of other intangibles, such as R&D and brand-building activities, EVA recognises that these are investments, not expenses, and treats them as such. Outlays for these activities are capitalised and amortised over appropriate periods of time instead of immediately deducting them from profits. This encourages managers to spend the appropriate amount in these areas while still holding them accountable for the eventual results.

Indian CEOs are, normally, quick to adopt management tools. But only one Indian company has actually implemented EVA. Even globally, we learn that only 365 companies that have implemented EVA over 18 years. Why is this so? Most companies have failed to adopt EVA, in India or elsewhere, because their managers are reluctant to adopt sweeping change. A handful do so because they recognise that it is the best course; and still others change because they are in trouble. Over time, however, the successes of those that have adopted EVA will convince others that they must do so to compete effectively tomorrow.

What happens when an EVA company acquires or merges with another company? What distortions are created by this M&A acti-vity, and how should they be handled? The ideal approach is to start by accounting for the full cost of purchase, and whatever goodwill is acquired, in the books of the company. A company's acquisition doesn't have to generate positive EVA from Day 1. The company, thus, has some leeway in consolidating the acquisition. However, the EVA system has a memory of what is promised, and what is, eventually, delivered 2 to 3 years later. Thus, short-term gaming disappears. Even with the best acquisitions, the fall in EVA is radical in the first 2-3 years. Since bonusplans are based on EVA, it is in the management's interest to make the company EVA positive. However, in many instances, acquisitions change the company's future-outlook in terms of EVA, and require a recalibration of the incentive-system.

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Since EVA is an annual measure, some people contend that it encourages the managers to focus only on the short term, and ignore the long-term repercussions of their decisions... This is a popular charge by our competitors, and one that, unfortunately, seems plausible to those not fully educated in the EVA system. The EVA system puts brakes on growth only when it is non-profitable. And because bonuses are based on EVA, the only way managers can continually earn large bonuses is by finding ways to profitably grow the business. This is better for shareholders than rewarding managers for any growth, regardless of whether it provides returns that are less than, or greater than the cost of capital.

When can an EVA initiative fail in an organisation? EVA will fail-that is, it will not change the behaviour of managers and workers-if it is not embraced enthusiastically by the CEO. It will fail if it is not used as the basis of incentive compensation; if you pay managers for something else, they will not strive to increase EVA. And, finally, it will fail when managers have a bureaucratic, rather than an entrepreneurial, outlook.

3.1 RESEARCH METHODOLOGY

Research in common practice refers to a search for knowledge .one can also define research as a scientific and systematic search for pertinent information on a specific topic. In fact, research is a art of scientific investigation. Research is an original contribution to the existing stock of knowledge making for its advancement. Research is the process of systematic and in depth

60

study or search for any particular topic, subject or area of investigation, backed by collection, compilation, presentation and interpretation of relevant details or data. Methodology as the name suggests methods through which the problem or situation is tackled. It involves a lot of factors like research design, sample size, segment, techniques of sampling, tools used etc all these factors put together brings out a clear and accurate result. Research methodology is a way to systematically solve the research problem. It may be understood as a science of studying how research is done scientifically. RESEARCH DESIGN: A Research design is the arrangement of conditions for collection and analysis of data in a manner that aims to combine relevance to the research purpose with economy in procedure. In fact,the research design is the conceptual structure within which research is conducted; it constitutes the blue print for the collection, measurement and analysis of data. As such the design includes an outline of what the researcher will do from writing the hypothesis and its operational implications to the final analysis of data.

ANALYTICAL RESEARCH
DIAGNOSTIC RESEARCH STUDIES: The studies concerning whether certain variables associated are of diagnostic research studies. In diagnostic studies, the researcher must be able to define clearly, what he wants to measure and must find adequate methods for measuring it along with a clear cut definition of Population he wants to study. The design in such studies must be rigid and not flexible and must focus attention on the following: a. Formulating the objective of the study. b. Designing the method of data collection. c. Selecting the sample.

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d. Collecting the data. e. Processing and analyzing the data. f. Reporting the findings. SAMPLING DESIGN DATA COLLECTION METHOD The study is conducted by collecting information from the secondary data. SECONDARY DATA : Secondary data consists of information that already exist, which has been sourced from various authentic and reliable sources like books, newspapers, trade journals and white papers, industry portals, government agencies, trade associations, monitoring industry news and developments. COLLECTION OF SECONDARY DATA: By way of caution, the researcher, before using secondary data, must see that they possess the following characteristics: 1. Reliability of data: The reliability can be tested by finding of such things about the said data: a. Who collected the data? b. What were the sources of data? c. Were they collected by using proper methods? d. At what time were they collected? 2.Suitability of data: The data that are suitable for one enquiry may not necessarily be found suitable in another enquiry.Hence,if the available data are found to be unsuitable,they should not be used by the researcher.

62

3.Adequacy of data: If the level of accuracy in data is found inadequate for the purpose of present enquiry,they will be considered as inadequate and should not be used by the researcher. SELECTION OF APPROPRIATE METHOD FOR DATA COLLECTION: 1.Nature, Scope and Object of enquiry: This constitutes the most important factor affecting the choice of particular method.The method selected should be such that it suits the type of enquiry that is to be conducted by the researcher. 2.Time factor: availability of time has also to be taken into account in deciding the particular method of data collection.some methods take relatively more time,whereas with others the data can be collected in comparatively shorter duration. 3.Precision required: Precision required is yet another important factor to be considered at the time of selecting the method of collection of data. Dr.A.L.Bowleys remark in this context is very appropriate when he says that In collection of statistical data common-sense is the chief requisite and experience the chief teacher. PERIOD OF THE STUDY The study is done for the period of four months . ANALYSIS AND INTERPRETATION: After collecting research data, it is necessary to analyze and interpret them. The purpose of analysis is to build up a sort of empirical model where relationships are carefully brought out so that some meaningful inferences can be drawn. Data has to be analyzed with reference to the objectives of the study.

EVA CALCULATION 1. Economic capital =

63

Shareholders equity 9 + + + good will written off Capitalized cumulative unusual loss Deferred tax +minority interest +total debt

2. Net operating profit after tax (NOPAT) = Operating profit + _ _ interest expense unusual gain taxes

3. weighted average cost of capital(WACC) Cost of equity Cost of debt WACC = (average out) 4. EVA = NOPAT- (capitalWACC)

CHI SQUARE TEST ANALYSIS:

The chi-square test a fairly, simple and definitely the most popular of all the other tools, the chi-square test is most widely used non-parametric tests in statistical work. It makes no assumption about being sampled. The quantity chi-square describes the magnitude of discrepancy between theory and observation.
( Oi Ei ) 2 = i =1 Ei
2
n

Where Oi refers to observed frequency

64

Ei refers to expected frequency N = No. of samples

PEARSONS CORRELATION TEST:

The concept of correlation which is one of the methods of studying the relationship between variables. Two variables may have a positive correlation, a negative correlation or they may be uncorrelated. The correlation between two variables is called as simple correlation.

r=

2 ( )

( )( )
2

2 ( )

CYCLICAL VARIATION:

The term cycle refers to the recurrent variation in time series that usually lost longer than a year and are regular neither in amplitude nor in length. Cyclical fluctuations are long term movements that represent consistently recurring rises and declines in activity. A business cycle consists of the recurrence of the up and down movement of business activity from some sort of statistical trend or normal. There are four well-defined periods or phases in the business cycle, namely 1) prosperity 2) decline 3) depression 4) improvement The study of cyclical variation is extremely useful in framing suitable policies for stabilizing the level of business activity that is for avoiding periods of booms and depressions as both are bad for an economy- particularly depression which brings about a complete disaster and shatters the company.

ANALYSIS AND INTERPRETATION

TABLE NO: 3.2.1

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TABLE SHOWING CALCULATION OF NOPAT FOR THE YEAR ENDED 2004-2005 FOR A PARTICULAR DIVISION OF BHEL (PSSR)
NOPAT= profit after tax+ interest cost (adj. for taxes)-non operating income PARTICULARS PROFIT BEFORE TAX Less: income tax@ PROFIT AFTER TAX INTEREST COST Less: tax on interest adjusted interested cost DRE charged off less: 1/5 th of VRS benefit adjusted extra-ordinary items RS(IN CRORES) 43.5 18.54 24.96

0 0 2.8 1.5 1.3

NON OPERATING INCOME interest income Less: tax on non operating income adjusted non operating income deferred tax on VRS NOPAT

2.75 1.17 1.58

1.19 23.49

Source: collected and compiled from the records and annual reports of BHEL

TABLE NO: 3.2.2 TABLE SHOWING CALCULATION OF NOPAT FOR THE YEAR ENDED 2005-2006 FOR A PARTICULAR DIVISION OF BHEL (PSSR)
66

NOPAT= profit after tax+ interest cost(adj. for taxes)-non operating income PARTICULARS PROFIT BEFORE TAX Less: income tax@ PROFIT AFTER TAX INTEREST COST Less: tax on interest adjusted interested cost DRE charged off Less: 1/5 th of VRS benefit adjusted extra-ordinary items RS(IN CRORES) 36.95 9.66 27.29

0 0 7.14 2.58 4.56

NON OPERATING INCOME interest income Less: tax on non operating income adjusted non operating income deferred tax on VRS NOPAT

6.02 2.61 3.41

3.1 25.34

Source: collected and compiled from the records and annual reports of BHEL NOPAT= profit after tax+ adjusted interested cost+ adjusted extraordinary items- adjusted non operating income +exchange variation-deferred tax on VRS.

TABLE NO: 3.2.3 TABLE SHOWING CALCULATION OF NOPAT FOR THE YEAR ENDED 2006-2007 FOR A PARTICULAR DIVISION OF BHEL (PSSR)

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NOPAT= profit after tax+ interest cost(adj. for taxes)-non operating income PARTICULARS PROFIT BEFORE TAX Less: income tax@ PROFIT AFTER TAX INTEREST COST Less: tax on intersest adjusted interested cost DRE charged off less: 1/5 th of VRS benefit adjusted extra-ordinary items RS(IN CRORES)

16.19 6.51 9.68

0 0

2.58 -2.58

NON OPERATING INCOME interest income Less: tax on non operating income adjusted non operating income EXCHANGE VARIATION deferred tax on VRS NOPAT

10.18 3.73 6.45 0.27 -0.94 1.86

Source: collected and compiled from the records and annual reports of BHEL

TABLE NO: 3.2.4 TABLE SHOWING CALCULATION OF NOPAT FOR THE YEAR ENDED 2007-2008 FOR A PARTICULAR DIVISION OF BHEL (PSSR)
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NOPAT= profit after tax+ interest cost(adj. for taxes)-non operating income PARTICULARS PROFIT BEFORE TAX Less: income tax@ PROFIT AFTER TAX INTEREST COST Less: tax on interest adjusted interested cost DRE charged off Less: 1/5 th of VRS benefit adjusted extra-ordinary items RS(IN CRORES) 58.92 23.94 34.98

0 0

1.08 -1.08

NON OPERATING INCOME interest income Less: tax on non operating income adjusted non operating income EXCHANGE VARIATION deferred tax on VRS NOPAT

10.56 4.2 6.36 0 -0.43 27.97

Source: collected and compiled from the records and annual reports of BHEL

TABLE NO: 3.2.5 TABLE SHOWING CALCULATION OF NOPAT FOR THE YEAR ENDED 2008-2009 FOR A PARTICULAR DIVISION OF BHEL (PSSR)

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NOPAT= profit after tax+ interest cost(adj. for taxes)-non operating income PARTICULARS PROFIT BEFORE TAX Less: income tax@ PROFIT AFTER TAX INTEREST COST Less:tax on intersest adjusted interested cost DRE charged off Less: 1/5 th of VRS benefit adjusted extra-ordinary items RS(IN CRORES) 109.1 37.14 71.96 -17.64 -5.94 -11.7

1.08 -1.08

NON OPERATING INCOME interest income Less:tax on non operating income adjusted non operating income EXCHANGE VARIATION deferred tax on VRS NOPAT

0 0 0 0 -0.37 59.55

Source: collected and compiled from the records and annual reports of BHEL

TABLE NO: 3.2.6 TABLE SHOWING CALCULATION OF NOPAT FOR THE YEAR ENDED 2009-2010 FOR A PARTICULAR DIVISION OF BHEL (PSSR)
70

NOPAT= profit after tax+ interest cost(adj. for taxes)-non operating income PARTICULARS PROFIT BEFORE TAX Less: income tax@ PROFIT AFTER TAX INTEREST COST Less:tax on intersest adjusted interested cost DRE charged off Less: 1/5 th of VRS benefit adjusted extra-ordinary items RS(IN CRORES)

95.62 33.32 62.3 -30.87 -10.49 -20.38

0 0

NON OPERATING INCOME interest income Less:tax on non operating income adjusted non operating income EXCHANGE VARIATION deferred tax on VRS NOPAT

0 0 0 0 0 41.92

Source: collected and compiled from the records and annual reports of BHEL

TABLE NO: 3.2.7 TABLE SHOWING CALCULATION OF EVA FOR A PARTICULAR DIVISION OF BHEL (PSSR)

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EVA = NOPAT- (capital employedWACC) EVA is calculated by substituting the value for WACC, NOPAT and capital employed

YEAR PAT NOPAT CAPITAL EMPLOYED WACC EVA

2004-05 24.96 23.49 22.14 12.06% 20.8199 2

2005-06 27.29 25.34 -26.08 12.32% 28.5530 6

2006-07 9.68 1.86 -63.02 11.64% 9.19552 8

2007-08 34.98 27.97 -94.4 12.32% 39.6000 8

2008-09 71.96 59.55 -96.95 14.00% 73.123

2009-10 62.3 41.92 -10.27 14.00% 43.3578

FINDINGS
From the above table it is found out that EVA for a particular division of BHEL (PSSR) for the year ended 2004-05 is 20.82, for the year ended 2005-06 it is 28.56, for the year ended 2006-07 it is 9.20, for the year ended 2007-08 it is 39.60, for the year ended 2008-09 it is 73.12, for the year ended 2009-10 it is 43.36.

INFERENCE
It is inferred that EVA for a particular division of BHEL (PSSR) is maximum for the year ended 2008-09 and EVA is minimum for the year 2006-07.

FIGURE NO: 3.2.1

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GRAPH SHOWING EVA FOR A PARTICULAR DIVISION OF BHEL 80 70 60 50 40 30 20 10 0 2005 2006 2007 YEAR 2008 2009 2010

EVA

TABLE NO: 3.2.8 A COMPARATIVE STUDY BETWEEN EVA AND NOPAT

YEAR NOPAT EVA 2004-05 23.49 20.8199 2 2005-06 25.34 28.5530 6 2006-07 1.86 9.19552 8 2007-08 27.97 39.6000 8 2008-09 59.55 73.123 2009-10 41.92 43.3578

FINDINGS
It is find out that the net operating profit after taxes (NOPAT) for the year 2004-05 is 23.50, NOPAT for the year ended 2005-06 is 25.34, for the year ended 2006-07 it is 1.86, for the year ended 2007-08 it is 27.97, for the year ended 2008-09 it is 59.55, , for the year ended 2009-10 it is 41.92.

INFERENCE
It is inferred that EVA for the year 2006-2007 is the least among the years since NOPAT for the year is the least.

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FIGURE NO: 3.2.2

TABLE NO: 3.2.9 A COMPARATIVE STUDY BETWEEN CAPITAL EMPLOYED AND EVA
YEAR CAPITAL EMPLOYED EVA 2004-05 22.14 20.8199 2 2005-06 -26.08 28.5530 6 2006-07 -63.02 9.19552 8 2007-08 -94.4 39.6000 8 2008-09 -96.95 73.123 2009-10 -10.27 43.3578

FINDINGS:
It is find out that capital employed for the year ended 2004-2005 is 22.14, for the year ended 2005-2006 it is -26.08, for the year ended 2006-2007 it is -63..02, for the year ended 2007-2008 it is -94.40, for the year ended 2008-2009 it is -96.95, for the year ended 2009-2010 it is -10.27.

INFERENCE:
It is inferred that capital employed for the year 2006-2007 is the least over the period and as the capital employed decreases EVA increases.

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FIGURE NO: 3.2.3

TABLE NO: 3.2.10 A COMPARATIVE STUDY BETWEEN PAT AND EVA

YEAR PAT EVA 2004-05 24.96 20.81992 2005-06 27.29 28.55306 2006-07 9.68 9.195528 2007-08 34.98 39.60008 2008-09 71.96 73.123 2009-10 62.3 43.3578

FINDINGS:
It is find out that profit after tax (PAT) for the year ended 2004-05 is 24.96, for the year ended 2005-2006 it is 27.29, for the year ended 2006-2007 it is 9.68, for the year ended 2007-2008 it is 34.98, for the year ended 2008-2009 it is 71.96, for the year ended 2009-2010 it is 62.30.
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INFERENCE:
It is inferred that PAT for the year 2006-2007 is the least over the period and hence EVA for the year is also found to be low.

FIGURE NO: 3.2.4

TABLE NO: 3.2.11 A COMPARATIVE STUDY BETWEEN EVA, CAPITAL EMPLOYED AND NOPAT
YEAR CAPITAL EMPLOYED EVA NOPAT 2004-05 22.14 20.81992 23.49 2005-06 -26.08 28.55306 25.34 2006-07 -63.02 9.195528 1.86 2007-08 -94.4 39.60008 27.97 2008-09 -96.95 73.123 59.55 2009-10 -10.27 43.3578 41.92

FINDINGS
It is found out that for the year ended 2006-07 EVA reaches its minimum figure since net operating profit after taxes is minimum. Capital employed for the year ended 2007-09 is
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minimum but EVA reaches its maximum figure since net operating profit after taxes for the year is maximum.

INFERENCE
From the above graph it is inferred that as the capital employed decreases for a particular year n EVA reaches its maximum figure.

FIGURE NO: 3.2.5

TABLE NO: 3.2.12 TABLE SHOWING CALCULATION OF CORRELATION COEFFICIENT BETWEEN NOPAT AND EVA Let X=NOPAT Y=EVA

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X 23.49 25.34 1.86 27.97 59.55 41.92 X=180.13

Y 20.82 28.56 9.19 39.60 73.12 43.36 Y=214.65

XY 489.06 723.71 17.09 1107.61 4354.29 1817.65 XY=8509.41

X2 551.78 642.12 3.46 782.32 3546.20 1757.29 X2=7283.17

Y2 433.47 815.67 84.46 1568.16 5346.53 1880.09 Y2=10128.38

r=

n xy x y n x ( x ) 2 n y ( y ) 2
2 2

XY=8509.41 ;

X=180.13;

Y=214.65;

X2=7283.17;

Y2=10128.38

Substituting the value in the above equation

r=0.475

Conclusion: By calculating correlation coefficient between NOPAT and EVA it is found that
these two factors are positively correlated. It is found out that correlation coefficient between NOPAT and EVA is +0.475

TABLE NO: 3.2.13 TABLE SHOWING CALCULATION OF CORRELATION COEFFICIENT BETWEEN CAPITAL EMPLOYED AND EVA
Let X= CAPITAL EMPLOYED Y=EVA

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X 22.14 -26.08 -63.02 -94.40 -96.95 -10.27

X=-268.58

Y 20.82 28.56 9.19 39.60 73.12 43.36

Y=214.65

XY 460.95 -744.84 -579.15 -3738.24 -7088.98 -445.31

XY=-12135.57

X2 490.18 680.16 3971.52 8911.36 9399.30 105.47

X2=23557.99

Y2 433.47 815.67 84.46 1568.16 5346.53 1880.09

Y2=10128.38

r=

n xy x y n x ( x ) 2 n y ( y ) 2
2 2

X=-268.58; Y=214.65; XY=-12135.57; Y2=10128.38

X2=23557.99;

Substituting the value in the above equation r=-0.475

Conclusion: By calculating correlation coefficient between capital employed and EVA it is

found that these two factors are negatively correlated. It is found out that correlation coefficient between CAPITAL EMPLOYED and EVA is -0.475

TABLE NO: 3.2.14 TABLE SHOWING CALCULATION OF CORRELATION COEFFICIENT BETWEEN WACC AND EVA
Let X= WACC Y=EVA X Y XY X2 Y2

79

12.06 12.32 11.64 12.32 14.00 14.00

X=76.34

20.82 28.56 9.19 39.60 73.12 43.36

Y=214.65

251.09 351.86 106.97 487.87 1023.68 607.04

XY=2828.51

145.44 151.78 135.49 151.78 196 196

X2=976.49

433.47 815.67 84.46 1568.16 5346.53 1880.09

Y2=10128.38

r=

n xy x y n x ( x ) 2 n y ( y ) 2
2 2

X=-76.34; Y=214.65; XY=2828.51; Y2=10128.38

X2=976.49;

Substituting the value in the above equation r=0.864

Conclusion: By calculating correlation coefficient between WACC and EVA it is found that
these two factors are positively correlated. It is found out that correlation coefficient between WACC and EVA is 0.864.

TABLE NO: 3.2.15 TABLE SHOWING CYCLICAL VARIATION FOR EVA

CYCLICAL VARIATION (RELATIVE RESIDUAL METHOD)

80

XY

X2

Y/

*100

Y/

Y
2005 2006 2007 2008 2009 2010 -5 -3 -1 1 3 5 X=0 20.82 28.56 9.19 39.60 73.12 43.36 Y=214.65 -104.1 -85.68 -9.19 39.60 219.36 216.8 XY=276.79 25 9 1 1 9 25 X2=70 16.03 23.93 31.83 39.73 47.63 55.53 129.88 119.35 28.87 99.67 153.52 78.09 *100 29.88 19.35 -71.13 -0.33 53.52 -21.91

Y =a+bx
a=35.78

b=xy/x2

a=y/n

b=3.95

Y =35.78+3.95x
Conclusion:
Cyclical variation for EVA is calculated over the period by relative residual method and it is found out that the largest fluctuation occurs in the year 2005.

FIGURE NO: 3.2.6

81

TABLE NO: 3.2.16 TABLE SHOWING CYCLICAL VARIATION FOR WACC

CYCLICAL VARIATION (RELATIVE RESIDUAL METHOD)

82

XY

X2

Y/

*100

Y-

Y
*100
2005 2006 2007 2008 2009 2010

Y/

-5 -3 -1 1 3 5 X=0

12.06 12.32 11.64 12.32 14.00 14.00 Y=76.34

-60.3 -36.96 -11.64 12.32 42 70 XY=15.42

25 9 1 1 9 25 X2=70

11.62 12.06 12.5 12.94 13.38 13.82

103.79 102.16 93.12 95.21 104.63 101.30

3.79 2.16 -6.88 -4.79 4.63 1.30

Y =a+bx
a=12.72

b=xy/x2 b=0.22

a=y/n

Y =12.72+0.22x
Conclusion:
Cyclical variation for WACC is calculated over the period by relative residual method and it is found out that the largest fluctuation occurs in the year 2005.

FIGURE NO: 3.2.7

83

TABLE NO: 3.2.17 TABLE SHOWING CYCLICAL VARIATION FOR CAPITAL EMPLOYED
CYCLICAL VARIATION (RELATIVE RESIDUAL METHOD)

84

XY

X2

Y/

*100

Y-

Y/

Y
*100
2005 2006 2007 2008 2009 2010

-5 -3 -1 1 3 5 X=0

22.14 -26.08 -63.02 -94.40 -96.95 -10.27 Y=268.58

-110.7 25 78.24 9 63.02 1 -94.4 1 -290.85 9 -51.35 25 XY=- X2=70 469.06

-11.26 -24.66 -38.06 -78.26 -64.86 -51.46

-196.63 105.76 165.58 120.62 149.48 19.96

-296.62 5.76 65.58 20.62 49.48 80.04

Y =a+bx
a=-44.76

b=xy/x2 b=-6.70

a=y/n

Y =-44.76-6.70x
Conclusion:
Cyclical variation for CAPITAL EMPLOYED is calculated over the period by relative residual method and it is found out that the largest fluctuation occurs in the year 2003.

FIGURE NO: 3.2.8

85

TABLE NO: 3.2.18 CHI-SQUARE TEST-CALCULATION: EVA

H0: EVA is evenly distributed evenly throughout all the years. H1: EVA is not distributed evenly throughout all the years.

Ei =

O
n

214.65 ==35.78 6

86

OI 20.82 28.56 9.19 39.60 73.12 43.36

EI 35.78 35.78 35.78 35.78 35.78 35.78

(OI-EI)2 223.8 52.13 707.03 14.59 1394.28 57.46

(OI-EI)2/EI 6.25 1.46 19.76 0.41 38.97 1.61

2 cal

68.46

(Oi Ei) 2 Ei i =1
n

2 cal 2 0.05 2 cal

=68.46 With (n-1) degrees of freedom =5df =11.1

>

2 0.05

At 5%, level of significance with (n-1) df , 2 0.05 with (n-1) df = (6-1) df = 5df = 11.1 The Calculated value is greater than table value, i.e.) 2 cal = 68.46 > 2 table = 11.1 Hence, H0 is rejected.

Conclusion:
By the method of chi-square it is concluded that EVA is not distributed uniformly throughout all the years since H0 is rejected.

TABLE NO: 3.2.19 CHI-SQUARE TEST-CALCULATION: CAPITAL EMPLOYED

H0: capital employed is evenly distributed throughout all the years. H1: capital employed is not distributed evenly.

Ei =

O
n

268.58 ==35.78 6

87

OI 22.14 -26.08 -63.02 -94.40 -96.95 -10.27

EI -44.76 -44.76 -44.76 -44.76 -44.76 -44.76

(OI-EI)2 4475.61 348.94 333.43 2464.13 2723.79 1189.56

(OI-EI)2/EI -99.9 -77.96 -7.45 -50.05 -60.85 -26.58

2 cal

-322.79

(Oi Ei) 2 = Ei i =1
n
0.05

with (n-1) degrees of freedom =5df

=11.1

2 cal

<

2 0.05

At 5%, level of significance with (n-1) df , 2 0.05 with (n-1) df = (6-1) df = 5df = 11.1 The Calculated value is greater than table value, i.e.) 2 cal = -322.79 < 2 table = 11.1 Hence, H0 is accepted.

Conclusion:
By the method of chi-square it is concluded that Capital employed is distributed uniformly since H0 is accepted.

TABLE NO: 3.2.20 CHI-SQUARE TEST-CALCULATION: WACC

H0: WACC is evenly distributed throughout all the years. H1: WACC is not distributed evenly.

Ei =

O
n

76.34 ==12.72 6

88

OI 12.06 12.32 11.64 12.32 14.00 14.00

EI 12.72 12.72 12.72 12.72 12.72 12.72

(OI-EI)2 0.44 0.16 1.17 0.16 1.64 1.64

(OI-EI)2/EI 0.03 0.01 0.09 0.01 0.13 0.13

2 cal

0.4

(Oi Ei) 2 = Ei i =1
n
0.05

with (n-1) degrees of freedom =5df

=11.1

2 cal

>

2 0.05

At 5%, level of significance with (n-1) df , 2 0.05 with (n-1) df = (6-1) df = 5df = 11.1 The Calculated value is greater than table value, i.e.) 2 cal = 0.4 > 2 table = 11.1 Hence, H0 is rejected.

Conclusion:
By the method of chi-square it is concluded that WACC is not distributed uniformly since H0 is rejected.

3.3 FINDINGS

EVA is calculated for the year 2004-05,05-06,06-07,07-08,08-09,09-10 and it is found to be 20.82,28.56,9.20,39.60,73.12,43.35 respectively.

A comparative study between EVA and NOPAT IS made and it is found out that EVA for the year 2006-2007 is the least among the years since NOPAT for the year is the least and EVA for the year 2006-07 is found to be 9.2.
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It is also found that capital employed for the year 2006-2007 is the least over the period and it is found to be -63.02.

It is found that PAT for the year 2006-2007 is the least over the period and it is found to be9.68.

It is inferred that as the capital employed decreases for a particular year ,net operating profit and EVA increases and reaches its maximum figure of 59.55 and 73.12 respectively.

By calculating correlation coefficient between NOPAT and EVA it is found that these two factors are positively correlated. It is found out that correlation coefficient between NOPAT and EVA is +0.475.

By calculating correlation coefficient between capital employed and EVA it is found that these two factors are negatively correlated. It is found out that correlation coefficient between CAPITAL EMPLOYED and EVA is -0.475.

By calculating correlation coefficient between WACC and EVA it is found that these two factors are positively correlated. It is found out that correlation coefficient between WACC and EVA is 0.864.

Cyclical variation for EVA is calculated over the period by relative residual method and it is found out that the largest fluctuation occurs in the year 2007 and the value is -71.13.

Cyclical variation for WACC is calculated over the period by relative residual method and it is found out that the largest fluctuation occurs in the year 2007 and the value is -6.88.

Cyclical variation for CAPITAL EMPLOYED is calculated over the period by relative residual method and it is found out that the largest fluctuation occurs in the year 2005 and the value is -296.62.

By the method of chi-square

it is concluded that EVA is not distributed uniformly

throughout all the years since H0 is rejected.

By the method of chi-square it is concluded that Capital employed is distributed uniformly since H0 is accepted.

90

By the method of chi-square it is concluded that WACC is not distributed uniformly since H0 is rejected.

By the method of least square the trend value for EVA is calculated and it is found out that the value increases gradually over the period and it is inferred that EVA for the enterprise increases year by year and is maximum for the year 2007-08 and the trend value is found to be 55.53.

By the method of least square the trend value for WACC is calculated and it is found out that the value increases gradually over the period and it is inferred that WACC for the enterprise increases year by year and is maximum for the year 2007-08 and the trend value is found to be 13.82.

By the method of least square the trend value for capital employed is calculated and it is found out that the value decreases gradually over the period and it is inferred that capital employed for the enterprise decreases year by year and is minimum for the year 2007-08 and the trend value is found to be -73.76.

3.4 SUGGESTIONS

91

Though EVA has some advantages over other performance indicators, it is a post-financial measure. (1) Enterprises need good strategies and value drivers like incentive based EVA to generate good EVA numbers. (2) For the EVA program to succeed, it must have full backing of the CEO and senior managers. (3) To reveal the true value of a multinational, it should design proper EVA adjustments according to each countrys accounting rules, laws and industry characteristics. (4) Enterprises should disclose full EVA information to investors, including adjustments and bonus plan. (5) Enterprises can use Balanced Scorecard and value-reporting tools to support the EVA performance indicator.

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3.5 CONCLUSION
EVA is simply a measuring tool , which points out where value is being created by the firm, and where it's not. In other words, EVA does not create value -- it simply measures it. What the firm does with this measure - it might even choose to ignore it - is a totally separate matter; in a rational market, maximizing EVA should maximize the firm's share price and, hence, shareholder wealth. The real reason why a firm's financials might improve after EVA adoption is twofold: 1) the measurement effect; and, 2) productivity increases - the real missing link between EVA and better financials. In general, these factors -- especially innovation and technology -- combine to accomplish one or more of four outcomes: 1) increased output per work-hour; 2) increased quality; 3) decreased costs; or 4) decreased error/defects. Any of these four outcomes is, by definition, an increase in the firm's productivity. From the firm's perspective, EVA is an internal financial tool which holds every manager in the firm accountable for every dollar allotted to them. From the market's perspective, EVA is a very useful tool with which the firm can maximize the value of the firm. EVA can be a powerful tool. When properly applied, it allows a firm to ascertain where it's creating value, and where it's not. More specifically, it allows a firm to identify where the return on its capital is outstripping the cost of that capital. For those areas of the firm where the former is indeed greater than the latter, EVA analysis then allows the firm to concentrate on the firm's productivity in order to maximize the value created by the firm. Finally, as investors buy more shares in the firm in order to have more claims on its increased value, they automatically bid up and eventually maximize the firm's share price. And, as any good capitalist knows, maximizing share price is the name of the game in a free-market economy.

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