Economic Value

Added
 Definition
 New York based financial advisory Stern
Stewart & Co. postulated the very concept
of Economic Value Added (EVA) in 1990.

• EVA : Maximum amount which the

business is capable of distributing to its
shareholders while remaining in the same
position at the end of the period as it was
at the beginning with fair practices. 2
 WHAT IS EVA TM
?
 EVA is a trademark of Stern Stewart & Co.
is a specific metric for calculating
economic profit.

 Enables the direct alignment of

management and shareholders interest-
“RICE,V.A.”

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 Necessity of E.V.A
It provides a suitable
framework for:

 The allocation of capital

among business units

 measurement of corporate
performance, and

 The determination of
executive incentive
compensation. 4
 It measures value creation;

 Eva is based on the foundation that to

create value a company must earn more
than its cost of capital.

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EVA and its Components

6
7
 Computation of EVA
EVA = ANOPAT -Cost of Capital

• ANOPAT =Adjusted Net operating Profit

after Tax
• The project’s cost of capital is the
minimum required rate of return on
funds committed to the project.
• The firm’s cost of capital will be the
overall (WACC), required rate of return
on the aggregate of investment projects
the projects.
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EXAMPLE – Consider the following firm:
 Sales $100,000,000
 Operating Profit $ 9,000,000
 Adjustments $ 1,000,000
 Debt $ 20,000,000
 Equity $ 40,000,000
 Tax Rate 30%
 WACC 10%
Thus,
– ANOPAT = $10,000,000 x (1 – 30%) = $7,000,000
– Total Capital = $20,000,000 + $40,000,000 =
$60,000,000
– Capital Charge = 10% WACC x $60,000,000 = $6,000,000
– Economic Value Added = ANOPAT - Capital Charge, =
$7,000,000 -$6,000,000 = +$1,000,000 9
 Advantages of Economic Value Added
• Transparency / Ease of Use
- Easy to calculate.
-Less subject to manipulation than earnings per
share.
-It is less variable than accounting earnings.
• Flexible
- Can easily be adapted across industries
- Adjustments to net operating profit can be
custom
- tailored to reflect company specific fact sets.
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 Conceptual

- Measuresif an executive is
generating company
earnings greater than a
comparably risky portfolio
of debt and equity.

-EV A causes the manager

to adopt the mentality of
a business owner, adopt
sound long-term decisions 11
 EVA Deficiency
 Not easy to use (for calculation of PAT,
some 144 adjustments are there) too
complicated for small business.

 Recommends inexpensive debts in order

to reduce cost of capital (COC), is a very
questionable strategy for small business.

 A passive accounting tool : measures past

performance. 12
 Review of Lterature
 FORTUNE magazine
has called EVA
“today’s hottest idea”.

 Peter F. Drucker
commented in
HBR:EVA measures
“total factor
productivity”.
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 Conclusion
we can definitely say that EVA™ has emerged as a
powerful conceptual framework and is practically
implemented in most of successful corporations
across globe. Which incorporates balance sheet data
into an adjusted income statement metric which
works best for companies whose tangible assets
(assets on the balance sheet) correlate with the
market value of assets - as is often the case with
mature industrial companies.

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