ECONOMIC VALUE ADDED Shareholders Wealth Creation through Economic Value Added (EVA): Maximizing the shareholders wealth

h means maximizing the net worth of the company for its shareholders Measures and Indications: Identifying the performance ,strengths and weaknesses suggesting improvement in future to analyze its financial performance to know the trend and progress over the period

Parameters for measurement

Traditional methods
Return On Net Worth (RONW) Return On Capital Employed (ROCE) Earning Per Share (EPS) Net Operational Profit After Tax (NOPAT) Earning Before Interest and Tax -EBIT

Modern methods
Market Value Added (MVA) Shareholder Value Added (SVA) Cash Value Added (CVA) Economic Value Added (EVA)

Certain parameters Return On Net Worth (RONW) Return On Net Worth (RONW) Profit After Tax 100 Net Worth The profits earned by the firm have to be related to Net Worth, which is the actual shareholders investment made in the business. Return On Capital Employed (ROCE)(ROI) Return On Capital Employed (ROCE)

Profit Before Interest and Tax 100 Debt + Equity The earnings before interest and tax earned by the firm has to be related to the total Capital Employed in the business. Earning Per Share (EPS) Earning Per Share (EPS) Profit After Tax Prefrence Dividend 100 Number of Shares Outstanding The total annual profits earned by the firm has to be divided by the total number of equity shares outstanding in order to determine profit per equity share. Economic Value Added (EVA) Economic Value Added (EVA) = NOPAT COCE NOPAT = Net Operating Profit After Taxes COCE = Cost of Capital Employed The returns earned have to be related to the Cost of Capital Employed while taking investment decisions by the firm.

Origin of EVA EVA is the invention of Stern Stewart & Co., a global consulting firm, which launched EVA in 1989. EVA is Economic Value Added, a measure of economic profit. EVA is nothing but a new version of the age-old residual income concept recognized by economists since the 1770s. EVACE = EVA 100 CE EVACE = Economic Value Added as a % of Capital Employed. EVA = Economic Value Added. CE = Capital Employed (Debt + Equity). Calculation of EVA Method 1 There are four steps in the calculation of EVA: 1. Calculate Net Operating Profit After Tax (NOPAT) 2. Calculate Total Invested Capital (TC) 3. Determine a Cost of Capital (WACC)

4. Calculate EVA = NOPAT WACC% (TC) Calculation of EVA Method 2 Economic profit = [ROIC Invested Capital] [WACC Invested Capital]

Advantages of EVA Highlight parts of the business that are not performing up to scratch Use of EVA implies delegated decision making Makes the cost of capital visible to operating managers Used down deep in the organization as an incentive compensation system Limitations EVA does not involve forecasts of future cash flows EVA would be negative in startup years, even if the project were on track to a strong positive NPV An economic point of view, the outlays are an investment, not an expense.

 EVA and other measures of residual income depend on accurate measures of economic income and investment. Criticisms Misleading as a wealth metric EVA is also shareholder-centric EVA is identical to residual income Significance Used to measure the financial performance Shareholders wealth creation and corporate governance Analysis helps us to know underlying business Mirror reflection of an organizations true performance Strengths of EVA Economic profit incorporates balance sheet data into an adjusted income statement metric. Works best for companies whose tangible assets (assets on the balance sheet) correlate with the market value of assets It conveniently summarises into a single statistic the value created above and beyond all financial obligations.

 It corrects the key deficiency or earnings and earnings per share (EPS) It helps managers clarify how they create value. Weakness Economic profit can be subject to accrual distortions. It has the limitations of any single-period, historical metric Any value obtained by employees of the company or by producer users is not included in the calculations. It is very risky to depend on a single metric. The companies least suited for economic profit are high-growth new-economy and high technology companies, for whom assets are off balance sheet or intangible.