Introduction Concept of Economic Value Added (EVA) Advantages of EVA Calculation of Economic Value Added (EVA) Measurement of Financial Performance Exercise A. Theory B. Practical yerere INTRODUCTIO! Normally the main objective of any organisation is to get profit rather it can be considered at maximisation of profit. Moreover, to achieve organisational goal within proper time is also main target of any company. Therefore, increasing profit shows success of the company in this regard. For this purpose, to check financial health of the company, financial statements should be studied. In this way, financial ratios may be utilised to check financial performance of the company. Though, financial ratios disclose financial health of the company but actual situation may be contradictory. For example, after utilisation of available resources, profit may be increased, but it also happened that company may not utilise all available resources. That is company cannot able to get maximum output from input of available resource. Hence, to check out the overall performance, requirement arises to for a new performance measurement tool apart from financial tool i.e. to economic value added called as EVA. 2. [ CONCEPT OF ECONOMIC VALUE ADDED (EVA): EVA approach measures the true profit position of the firm Stem Stewart & Co. developed EVA concept which is now popular to estimate firm's economic profit. In simple term, BVA is the profit earned by the firm less the cost of financing the firm's capital, Economic Value Added (EVA) is a company’s performance measurement tool to check the value created for shareholders apart from financial performance. It is computed as the “excess return” made on capital investments. As Stewart mentioned “Economic Value Added (EVA) is the net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise or project. It is an estimate of true economic profit, or amount by7 which eamings exceed or fall short of the required oa a? investors could get by investing in other securities of comparable risk. ae Since, the creation of shareholder value has become the wvaciieae Purpose of a corporation which is also considered as wealth maximi i a ‘other words, organisation mainly focuses on greater return than the firm S cost capital, thus ensuring maximization of shareholder value. In this way EVA is a strategy formulation as well as financial performance tool for ee that helps companies to make a greater return than the firm’s overall cost of capital. A firm Stern Stewart, defined EVA as EVA = NOPAT- (Invested Capital x WACC). Where, EVA = Economic Value Added NOPAT = Net Operating Profit After Tax WACC = Weighted Average Cost of Capital Alternate formula of calculating EVA is as under: EVA = Earnings After Taxes - Cost of shareholders’ funds Here, Cost of shareholders’ = Cost of equity funds + Cost of preference share funds capital Cost of equity funds = Cost of equity share + Cost of Retained capital earnings ADVANTAGES OF EV. EVA focus both profit and loss as well as balance sheet efficiency as well as the Opportunity cost of investor capital- it is better linked to changes in shareholder’s wealth and is superior to traditional financial metrics such as PAT or measures such as ROCE or ROE, EVA is 4 management tool to focus managers on the impact of their decisions in increasing shareholder's wealth, These include both strategic decisions (Such as what snvestnents to make which businesses to exit, what financing structure is optimal) as well 4s operational decisions such as whether to make in house or outsource, rep eplac Piece of equipment, whether to make short or long pr EVA is considered as a simple measur shareholders’ wealth creation, In other management for their performance for creating shareholders’ value. In this EVA is useful to management in following manner (1) EVA becomes helpful for taking better investment decisions, (2) Identification of improvement in Opportunities is Percentage rate of retum ‘oduction Tuns ete. © 0 check the real picture of words it is motivational tool also possi(4) (5) (6) 7) (8) 9) It measures the quality of managerial decisions and indicates the value growth in the future. The calculation system of EVA is very easy that is it can be easily calculate from the information availabie form P & L A/c and balance sheet. EVA shows actual economic profit of the company. It helps for controlling Agency conflict and also helps to improve decision making system. In compared to other measures, it si strongly associated with stock return i.e. it helps to Improves Stock Performance of the organisation. It is an effective measure to check the quality of managerial decisions and considered as a reliable indicator of a Company’s value growth in the future. It means, constant positive EVA values over time will increase commnatiee values, and vice a versa.eP-2 Fm oy Vaca Gast of Equity. oe w__fare of equi \eo Wy eos of Reef CrP itell | Nacsiseae) ee 7 (ost of clebt. smtrest an debt > Tax on intrestParticulars EBIT (Earnings Before Interest and Tax) Less: Interest on 12% Debt 9.0 ee Crore Crore Earnings before taxes a5 Crore Less: Corporate taxes (30%) 2. 25 = Crore Earnings after taxes 5.25. “Crore Less: Dividend on 13% preference share capital 0.975 Crore Earnings for equity shareholders 4.275 Crore Equity funds (having Cost of 16%) = % 20 crore Also calculate EVA as a percentage of total capital employed.iS ea x ry & A aApnA [-S#el- 2D) VA GOs i. oe Se [Cost OF | Equity Shure. [2e x \e1) i (ost Of Pref Share. Cgividend Paid = cost) - Oe 945 eI Cesk of debt. ek 2 ae Co Wtmbyest aioe eis 005.Ree ee eee ea Illustration: From the following income statement of Z Ltd. for the current year calculate EVA (Economic Value Added) during the year: PSC di rr) 50. 00 Sales revenue Less: Operating Costs 30. 00 Less: Interest Costs 1. 20 Earnings before taxes 18. 80 if S2, Less: Taxes (40%) Earnings after taxes PL UROAS The firm’s existing capital consists of % 15 crore equity funds, having 15% _ cost and of 10 crore 12% Debt.evenUue. | | Toes ee | Stee: | Cost of Equity. he is x 1a} [@st_of Qebt fea (een eX Less! ax (2x hor) I on Elel= ply loved tink. ardA High market value added means mat the company has created substantial wealth for shareholders. On the other hand negative EVA means that the value of Management’s actions and investments are less than the value of the capital contributed to the company by the capital market or that the wealth and value has been destroyed. The following information of XYZ Ltd is available calculate E.V_A.: Debt capital 12% = 2,000 Crores Equity Capital = 500 Crores Reserve and surplus = 7,500 Crores Capital employed = 10,000 Crores Cost of Equity : 19.5% Net Operating profit after tax = 2,100 Crores Tax rate 30%Illustration 4; ; X Lid. supplies the following information using which you are required to calculate the economic value added. Financial Leverage 1.4 times Capital (equity and debt) (1) Equity shares of € 10 each 60 lakhs (number) (2) 10% Debentures of & 10 each 80 lakhs (number) Dividend expectations of equity shareholders 17.50% Prevailing Corporate Tax Rate 30% fers tdman Gel, Leverage = Egz : esis wi >{ SREB RE MY Finan ial Leveraae => )oy ~> Fert =) Ree aS pete EB IT - Ree tntyese | : ois Fert <~ oslo f a> Tnryes: = Reo Lakhs x Flo = Se imt on dAeb-= Reolakhs x jor = Bo lakhs 1 : pipes EBIT re _ Ferr - Ro leks : Bo, €G21 = Oo. Lakhs. ~ VOPAT #® - meer D8 1k Ikc5 “axes; 280 % Ba%/ Sh Lak! Nerar. 196 lakhsRe Gckts el Equi py Shue.” QPe= Coe Lakhs x Flos ocw Lakhs Poot = aluidend. Reo tans x» fe 5 ls I) Coe Of) debenture IMeh= So Lakhs: x Flo = Gow Jaks J Imy = Roe@atchs Kloy = Ro nee ates C Bo x 80°F). =24 ol Prof. kiskun Kotedu i , | eae a (eaeFrom the following information of Raj Ltd., compute the economic value added: (1) Share Capital = 2,000 Lakhs (2) Reserve and surplus = 4,000 Lakhs (3) Long-Term Debt z 400 Lakhs (4) Tax rate 30% (5) Cost of equity 16.35% LS] 4m Le >: ~40Q—Lakhs (6) Interest (7) | Profit before interest and tax = 2,000 LakhsQeee x Zo /-) ——————— (VoPAT - yp Oo Lakhs | SteP= 2 WACC. | | Rs_im Lakhs fe (ost of Fauiey Shure. #2009 x 16-35 7 i e (ot pf fletamed Eurninas | Res & Surplus x Rate of Cost of Eduits} | tes Ciyeco x 16:35 f= 9 j et S ¢ Cost of Debt mm breSt Nygee oe oS = os an int Cue x3ov) 7 S2 wacc. Prof Kishan Kotecha a Bier =a. EVA t ss [VoParPRACTICAL: MN Ltd. provides you with the following summarized balance sheet as at Additional information provided is as follows: (1) Profit before interest and tax is % 2,202.84 lakhs (2) Interest paid is % 13.48 lakhs. (3) Tax rate is 40% (4) Cost of equity = 12.42% and cost of debt = 5.6% You are required to calculate Economic Value Added of Ltd. [Ans.: EVA = 1028.48 Lakhs] [Ex.24 The Capital Structure of ABC LTD. is as under: (1) 80,00,000, Equity Shares of % 10 each = % 800 Lakhs (2) 1,00,000, 12% Preference Shares of ¥ 250 each = & 250 lakhs (3) 1,00,000, 10% Debentures of & 500 each = % 500 lakhs (4 Terms Loan from Bank @ 10% =% 450 lakhs, The Company’s Statement of Profit and Loss for the year showed profit before Interest and Taxes = % 1578.33 Lakhs, The Company is in the 40% tax bracket Treasury Bonds carry 6.5% interest and cost of equity = 21.5%, Caleulate Economic Value Added, [Ans.: EVA = 88 lakhs,] [x34 Calculate economic value added (EVA information of New Limited, Financial Leverage 1.4 times Capital (equity and debt) (1) Equity share Capital & 179 Lakhs (2) Reserves & Surplus 130 Lakhs (3) 10% Debentures % 400 Lakhs 17.50% 30% ) with the help of the following Cost of Equity“Economic Value Added ce 2 From the following income Statement of ox. Lid, for 2014-15, calculate the EVA, Sales revenue Less: Cost of goods sold Administrative expenses Selling expenses Interest Sass Earnings before taxes Less: Taxes (0.40) Earnings after taxes The firm’s weighted average cost of tot a! capital employed (consisting of equity and debt of = 150 crore) is 12%; its cost of equity capital is 15%. {Ans.: % 6 crore.] Ex. 5:| Determine EVA from the following data of TZ Ltd. Particulars (in crore) | EBIT 36.0 Less: Interest on 12% Debt. 6.0 Earnings before taxes Less: Corporate taxes (30%) 9. Earnings after taxes 25. Less: Dividend on 13% Preference Share Capital 3 (% 30 crore x 0.13) Earnings for equity share holders 17.1 Earnings funds (having cost of 16%) % 80 Crores Also determine EVA as a percentage of total capital employed. Ans.: EVA = 4,30 crore; EVA as a % of total capital employed = 2.69%.] Ex. 6:| Following is income statement of New Ltd. for the current year: Particulars (Zin lakh) Sales revenue = 500. 0 Less; Operating costs 300.0 200. 0 Less: Interest costs Q Earnings before taxes 0 Less: Taxes (0,40) Earnings after taxes The firm’s existing capital consists of % 150 lakh equity funds, having 15% cost and of € 100 lakh 12% debt. Determine the economic value added during the year. [Ans.: EVA =% 90.3 Lakh] eee