Economic Value Added

(EVA)
Presented by:
NEEL
BHAVIK
AMIT
VINIT
 Introduction of EVA
 EVA was developed by a New York consulting firm, Stern
Steward & Co. in 1982 to promote value-maximisig
behaviour in corporate managers.

 Value-based measure to evaluate business strategies,

capital projects and to maximise long-term shareholders
wealth.

 EVA sets managerial performance target and links it to

reward systems.

 Unlike simple traditional budgeting. EVA focuses on ends

and not means.
 Definition for EVA
EVA is defined as net profit after taxes and after the cost of
capital.
FORMUALE for EVA

EVA

Net operating profit Taxes Cost of capital

Calculating Net Operating After Tax
(NOPAT)
NOPAT is easy to calculate. From the income statement we
take the operating incomes and subtract taxes.
Particulars Amount (Rs.)
e.g. XYZ Company
Sales 24,36,000/-
Cost of Goods sold (-) 17,00,000/-
Gross Profit 7,36,000/-
Selling, general & Admin 4,00,000/-
Exp. (-)
Operating Profit 3,36,000/-
Taxes (-) 1,34,000/-
NOPAT 2,02,000/-
 Cost of Capital
Meaning: The cost of capital is the rate of return required by
the shareholders and lenders to finance the operations of the
business.

Types of Cost of Capital

Equity Capital: Equity Capital is provided by the Shareholders.

Borrowed Capital: It is the Capital borrowed by the company

from Banks and other Financial Institutes.
 Weighted Average Cost of Capital
(WACC)
Weighted Average Cost of Capital examines the various
components of the Capital structure and applies the
weighting factor of after-tax cost to determine the cost of
Capital.
Calculating WACC
e.g. XYZ Company
Particulars Amount (Rs.)
Long Term Debt 5,00,000/-
Preferred Stockholders Equity 2,00,000/-
Total Common Equity 7,00,000/-
Total Capital 14,00,000/-
 WACC Continue
Long Term Debt
Bond Cost

Bond Rs. 100/-

Net Return (Deducting discounting & Financing cost) Rs. 96/-

Interest 14% (Rs. 14/-)

Assumed Tax 35% (Rs. 5/-)

Interest After Tax (Rs.14 – Rs. 5) 9%

Cost for Bond Financing (9/96 x 100) 9.47%
 WACC Continue
Preferred Stock Cost

Preference Share (Per share) Rs. 100/-

Net Revenue (Deducting discount & financing cost) Rs. 98/-
Dividend 11% (Rs. 11/-)
Cost for Preferred Share (11/98 x 100) 11.2%
 WACC Continue
Common Equity Cost

Share Price (Per Share) Rs. 100/-

Net Return (Less issuing cost) Rs. 85/-
EPS (Estimated by investors & reliable analyst) Rs. 12/-
Cost for Common Equity (12/85 x 100) 14.1%
 WACC Continue
Summarizing

Bond Cost 9.47%

Preferred Stock Cost 11.2%

Common Equity Cost 14.1%

 Calculation of WACC
for XYZ Company
Particulars Amount Cost Total
(Rs.) (%) (Rs.)
Long Term Debt 5,00,000/- 9.47 47,375/-
Preferred Stock Cost 2,00,000/- 11.2 22,400/-
Common Equity Cost 7,00,000/- 14.1 98,700/-
Total Capital 14,00,000/- - 1,68,475/-

The total Weighted Average Cost of Capital (WACC) =

1,68,478 / 14,00,000 = 12.03%
 Calculation of EVA
for XYZ Company
NOPAT Rs. 2,02,000/-
Capital Employed Rs. 15,00,000/-
(Including Rs.1,00,000/- Reserve & Surplus)
Cost of Capital 12.03%
Capital Charge (12.03/100 x Rs. 15,00,000/-) Rs. 1,80,450/-
Economic Value Added (EVA) Rs. 21,550/-
(Rs. 2,02,000 – Rs. 1,80,450)
 Strategies for Increasing EVA
 Increase the return on existing projects (improve operating
performance).

 Invest in new projects that have a return greater than the cost
of capital.

 Use less capital to achieve the same return.

 Reduce the cost of capital.

 Liquidate capital or curtail further investment in sub-standard

operations where inadequate returns are being earned.
 Advantages of EVA

 EVA provides for better assessment of decisions that affect

balance sheet and income statement or tradeoffs between
each through the use of the capital charge against NOPAT.

 EVA decouples bonus plans from budgetary targets.

 EVA covers all aspects of the business cycle.

 EVA aligns and speeds decision making, and enhances

communication and teamwork.
 Limitations of EVA
 EVA does not control for size differences across plants or
divisions.

 EVA is based on financial accounting methods that can be

manipulated by managers .

 EVA may focus on immediate results which diminishes

innovation.

 EVA provides information that is obvious but offers no

solutions in much the same way as historical financial
statement do.
 Conclusion

As a performance measure, Economic Value Added forces the

organization to make the creation of shareholder value the
number one priority. EVA is changing the way managers run
their businesses. When business decisions are aligned with the
interest of the shareholders, it is only a matter of time before
these efforts are reflected in a higher stock price.