EVA COMPONENTS AND THEIR IMPACT ON MVA: A CASE STUDY

ON REGENCY CERAMICS Ltd.

M. Suman Kumar
Assistant Professor
Department Of Business Administration
Annamacharya PG College of Computer Studies
Rajampet-516126
9703646181
sumanmunagari@gmail.com

ABSTRACT
EVA is an attempt to measure the true economic profit it measures whether the operating
profit are sufficient enough to cover the cost of capital. EVA is the most successful parameter
which is used by companies and consultants. The utility of EVA simply does not end by
indicating the degree of wealth creation it goes beyond that pin point the lacunae in the business
performance. This paper analyses the association between components of EVA and their impact
on MVA of REGENCY CERAMICS Limited. Components of EVA and MVA over the period from
2003 to 2010 are modeled as linear regression system in multiple correlation and regression
analysis, test of multiple regression confirms that there is no strong association between EVA
and MVA. All the components of EVA is not showing significant influence on MVA only cost of
capital employed show the significant impact on MVA, Cost of Capital employed showing
negative impact on MVA.

Key words: Economic Value Added (EVA), Market Value Added (MVA), Regression, Multiple
Correlation.
INTRODUCTION

Exploiting shareholder value has become the new corporate paradigm. Although
shareholder wealth maximization has traditionally recognized by managers and researchers as
the ultimate corporate goal, the maxim has gained in new dimension in recent years, thanks to
concept of EVA( Economic Value Added) coined and registered by Stern Stewart & Co New
York. EVA is residual income that subtracts the cost of capital from operating profits generated
by a business[ CITATION Ash00 \l 1033 ] . EVA is an attempt to measure the true economic profit it
measures whether the operating profit are sufficient enough to cover the cost of capital. EVA is
the most successful parameter which is used by companies and consultants [CITATION Ram08 \l
1033 ]. The development of Indian capital market, both in depth and breadth along with the
increased awareness among the shareholders, has increased the pressure on the companies
consistently perform better. One of the indicators of such performance is Market Value Added
(MVA). These measures recognize that capital invested in corporation is not free, and make a
charge for the use of the capital employed by the corporation in its operations [ CITATION OHa98 \l
1033 ] . Advance of these value drivers leads to an increase in shareholders’ value. A common
theme of the value based performance measures is that they take these drivers and summarize
them into a single measure, be it EVA, MVA or any of the other value based performance
measures that have been developed.

REVIEW OF LITERATURE

Stewart [CITATION Joe \n \t \l 1033 ] has first studied the relationship with market data of
618 US companies. Stewart observed that the relationship between EVA and MVA is highly
correlated among US companies.[ CITATION Leh96 \l 1033 ] in their study of 241 US companies
over two periods (1987-1988 and 1992-1993) observed that both measures (EVA and MVA)
correlate positively with stock returns and that the correlation is slightly better with EVA than
that with traditional performance measures like return on assets (ROA), return on equity (ROE),
etc. On the predictive power of EVA in explaining MVA or shareholder wealth, several
researchers (for example, Uyemura, Kantor and Petit, 1996; McCormack and Vytheeswaran,
1998; O'Byrne, 1996; Milunovich and Tsuei, 1996; Grant, 1996) observed that EVA is better
correlated with MVA or shareholder wealth than other traditional parameters like ROCE,
RONW, EPS, etc. However, there are adverse findings too.
 Dodd and Chen[CITATION Dod96 \n \t \l 1033 ] found that return on assets (ROA)
explained stock returns better than EVA. Hamel [CITATION Ham97 \n \t \l 1033 ] was critical
about the superiority of EVA. He opined that EVA reveals little about a company's share of new
wealth creation. Biddle [CITATION Bid98 \n \t \l 1033 ] revealed that EVA has a high correlation
with market value added (the difference between the firm's value and cumulative investor
capital) and thereby stock price. Brewer[CITATION Bre99 \n \t \l 1033 ] recommends that EVA
provides Better goal correspondence than ROI.

Stern [CITATION Ste01 \n \t \l 1033 ] declared that there is a strong correlation between the
change in EVA and change in MVA. Dr D.V. Ramana [CITATION DrD05 \n \t \l 1033 ] found that
there is no strong evidence to support SS claim that EVA is superior to the traditional
performance measures in its association with MVA. NOPAT and PAT better explain MVA.
Market responds to the accounting numbers more than that with the numbers which are created
generated using some adjustments. So one should be careful in overusing the EVA as a proxy
for MVA. Thus there is no clear evidence to support the claim that the shareholders stand to gain
by looking at EVA. However, the usefulness of EVA for decision-making cannot be ruled out.

Ramachandra Reddy and Yuvaraja reddy [CITATION Ram08 \n \t \l 1033 ] made study on
cement companies in India. The study found that none of the factor found to have impact on
MVA. The study concluded that the performance of select cement companies in terms of
profitability cannot be increased unless the improved problems like modernization, cost
reduction, control taxes etc., are solved. Therefore present paper made an attempt to analyze the
EVA components and their impact on MVA.

OBJECTIVES

 To examine the impact of EVA on MVA by computing simple correlations between

MVA and components of EVA and test significance of such coefficients.
 To assess the joint effect on above components up on the MVA with the help of multiple
correlation coefficients and multiple regression equation and to test significance of
regression coefficient.
METHODOLOGY
THE CASE STUDY
This case study intends to analyses the correlation between Components of EVA and MVA
Descriptive research design has been adopted in the present study; descriptive research design
largely interprets the already available information. The data relating to the study have been from
the published annual reports of REGENCY CERAMICS LIMITED for the period of 2003 to
2010. The secondary data has been collected from other publications

DATA ANALYSIS AND INTERPRETATION

Table 3.1 ECONOMIC VALUE ADDED FROM THE YEARS (2003 – 2010)

(Rs in crores)
Particulars 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11
Equity 13.59 13.6 13.6 13.6 13.59 13.59 26.44 26.44
Reserves & surplus 53.76 52.58 52.63 48.96 33.54 18.9 18.7 18.7
Debt (%) 7 130.22 119.32 120.52 119.64 137.31 131.68 133.64
Capital employed (1+2+3) 74.33 196.4 185.55 183.08 166.78 169.6 176.82 178.81
Cost of equity (%) 0.26 0.018 0.008 5.87 0.327 0.459 0.296 0.342
Cost of retained earnings (%) 0.252 0.017 0.007 5.57 0.31 0.436 0.281 0.325
WACC (%) 0.2449 0.0903 0.078 0.138 0.42 0.538 0.3766 0.4269
COCE 18.21 17.73 14.47 25.26 70.04 91.24 66.59 76.76
NOPAT 17.16 -1.18 0.05 -3.67 15.42 -14.84 -13.38 -15.44
EVA (9) – (8) -1.05 -18.91 -14.42 -28.93 -54.62 -106.08 -79.97 -92.2
Source: Data collected from annual reports of “Regency Ceramics Limited”

Interpretation
From the above table observed that the Return on equity of the company fluctuated year
after year because profit after tax was instable. Cost of equity was high in 2003-04 and 2007-11
it was decreased in 2004-07. Cost of debt of the company was high in 2003 and low in year by
year. Cost of retained earnings was high in 2003 and 2007-11 it was decreased 2004-07 because
of cost of equity was not stable. Weighted average cost of capital of the company high in 2003-
04 to 2007-11 because cost of debt, cost of equity was increased year by year.

Cost of capital employed of the company was high in 2003 and 2007-11 and low in 2004-
07 because of capital employed was decreased year by year. Net operating profit after tax
decreased year by year except 2003-04 because tax was reduced.
 Economic value added explains the relationship between NOPAT and WACC. EVA of
the company was negative during study period because net operating profit was low and cost of
capital employed was high.
Table 3.2 MARKET VALUE ADDED FROM THE YEARS (2003 – 2010)
MVA= Share Outstanding (share price)-Total Common Equity

(Rs in crores)

No of Shares Total Common

Year Outstanding Share Price Equity MVA
2003-2004 1.3592979 50 13.59 54.37
2004-2005 1.35968 34.4 13.59 32.2
2005-2006 1.35968 19.85 13.59 13.2
2006-2007 1.35968 16 13.59 8.01
2007-2008 1.35968 15.5 13.59 7.33
2008-2009 1.35968 6.22 13.59 -5.19
2009-2010 2.64,41,586 7.99 26.44 -5.31
2010-2011 2.64,41,586 6.65 26.44 -8.85

Source: Data collected from annual reports of “Regency Ceramics Limited”

Interpretation:

The above table reveals that the market value added was high in 2003-2004 and
decreased year after year, because due to market stock price was decreased 2004-2011 during the
study period. In 2003-04 MVA was high after it was gradually decreased because market stock
price was low and total common equity was stable. Market value added is showing declining
trend during the study period because of share price value decreased. Hence by increasing
earnings per share and dividend per share by retention ratio are by increasing profits to company
may increase their value in the market.

CORRELATION MATRIX
Table 3.3

  Equity R&S DEBT CE COE CORE WACC COCE NOPAT EVA MVA

Equity 1 -0.69 0.29 0.184 -0.194 -0.194 0.397 0.472 -0.598 -0.571 -0.544
Reserves and surplus -0.69 1 -0.5 -0.237 0.226 0.226 -.888** -.954** 0.653 .975** .807*

DEBT 0.29 -0.5 1 .954** 0.078 0.078 0.193 0.46 -0.697 -0.595 -.822*
CAPITAL
EMPLOYED 0.184 -0.237 .954** 1 0.156 0.155 -0.106 0.178 -0.594 -0.336 -0.661

Cost of equity (%) -0.194 0.226 0.078 0.156 1 1.000* -0.275 -0.218 -0.073 0.151 -0.111
Cost of retained
earnings -0.194 0.226 0.078 0.155 1.000* 1 -0.275 -0.218 -0.072 0.151 -0.11

WACC 0.397 -.888** 0.193 -0.106 -0.275 -0.275 1 .959** -0.315 -.869** -0.559

COCE 0.472 -.954** 0.46 0.178 -0.218 -0.218 .959** 1 -0.492 -.959** -.752*

NOPAT -0.598 0.653 -0.697 -0.594 -0.073 -0.072 -0.315 -0.492 1 .718* .749*

EVA -0.571 .975** -0.595 -0.336 0.151 0.151 -.869** -.959** .718* 1 .844**

MVA -0.544 .807* -.822* -0.661 -0.111 -0.11 -0.559 -.752* .749* .844** 1
Source: Data collected from annual reports of “Regency Ceramics Limited”

Interpretation:

Equity is the correlated with WACC, COCE but the remaining Variable are negatively
correlated. R&S is significantly correlated with EVA and having significant correlated with
WACC&COCE. Debt is the correlated with WACC, COCE but the negatively correlated with
EVA & MVA. Capital employed is the negatively correlated with NOPAT, MVA but the
remaining variables are positive. WACC is the COE & MVA. Remaining variables are positive.
EVA is the negative in WACC, COCE. Positive with COE, NOPAT, MVA.

MULTIPLE REGRESSION

Multiple Regression is carry out to study the impact of EVA Components on MVA. Here
X1, X2, X3 are taken as independent variables which represents as the determinants EVA of the
firm where are MVA is taken as dependent variable representing shareholders wealth of the firm.

A regression model has given bellow is considered to assess the impact of EVA on MVA.
 MVA = B0 + B1 X1+ B2 X2 + B3 X3
X1 = Weighted average cost of capital
X2 = Cost of Capital Employed
X3 = Net operating Profit after tax

Model Summary
Std. Error of the
Model R R Square Adjusted R Square Estimate
1 .948a .898 .822 9.12099

ANOVAb
Sum of
Model Squares df Mean Square F Sig.
1 Regression 2939.503 3 979.834 11.778 .019a
Residual 332.770 4 83.193
Total 3272.273 7
a. Predictors: (Constant), NOPAT, WACC, COCE
b. Dependent Variable: MVA
 Coefficientsa
Standardized
Unstandardized Coefficients Coefficients

Model B Std. Error Beta t Sig.

1 (Constant) 26.934 6.675 4.035 .016
WACC 213.554 89.722 1.729 2.380 .076
COCE -1.604 .543 -2.341 -2.954 .042
NOPAT .238 .399 .141 .595 .584
a. Dependent Variable: MVA

As it can be seen from table 1 B about model considered significant model (F=11.778,
P.> 0.05) with R2 value of 0.898 that means variables considered contribute 89% variance in
MVA. Hence EVA determinants are explained variance in the MVA.

However it has depicted in table 1C not all the determinants of EVA show significant
influence on MVA only cost of capital employed show the significance on MVA, Cost of Capital
employed showing negative impact on MVA.

CONCLUSION
Today one of the major goals of financial management is maximum utilization of the capital
employed. Since capital resources are scarce and costly, companies try to employ these resources in a
way that yield highest return. Of course this should be accompanied by steps taken to minimize the cost
of acquired resources. Otherwise, it will not increase the shareholders wealth and firm’s value. Economic
Value Added has been put use for management performance evaluation and much more than just a
measure of performance, it is a framework for complete financial management. On the other hand,
Market Value Added (MVA) is an indicator which measures the stock return and shows the effect of
different factors on share price, in a particular market. While EVA is an accounting-based measure for the
corporate performance of one year.
 We examined the EVA Components and their impact on MVA. Therefore it is concluded that
All the components of EVA is not showing significant influence on MVA only cost of capital
employed show the significant impact on MVA, Cost of Capital employed showing negative
impact on MVA.
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