Computation of Economic Value Added (EVA) of Sample Companies M P Birla Institute of Management, Bangalore 1 Computation of Economic Value Added (EVA) of Sample Companies A dissertation submitted in partial fulfillment of the requirements for the award of MBA degree of Bangalore University. Submitted By Ashwani Kumar Kedia (REGD. NO: 05XQCM6013) Under The Guidance and Supervision OF Dr. N. S. Malavalli, Principle M.P. Birla Institute of Management. M. P. BIRLA INSTITUTE OF MANAGEMENT Associate Bharatiya Vidya Bhavan # 43 Race Course Road, Bangalore-560001 2006-07
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Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 1
Computation of Economic Value Added (EVA) of Sample
Companies
A dissertation submitted in partial fulfillment of the requirements for the award of MBA degree of Bangalore University.
Submitted By
Ashwani Kumar Kedia
(REGD. NO: 05XQCM6013)
Under The Guidance and Supervision OF
Dr. N. S. Malavalli, Principle M.P. Birla Institute of Management.
M. P. BIRLA INSTITUTE OF MANAGEMENT Associate Bharatiya Vidya Bhavan
# 43 Race Course Road, Bangalore-560001 2006-07
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 2
DECLARATION
I, Ashwani Kumar Kedia, do hereby declare that this project report entitled
“Computation of Economic Value Added (EVA) of Sample Companies” is an
original research work carried out by me, towards the partial fulfillment of requirements
for the M.B.A. degree course of Bangalore University at M.P. Birla Institute of
Management. I also declare that this dissertation has not been submitted to any
University/Institution for the award of any Degree/Diploma.
Place: Bangalore
Date: 15th May 2007 (Ashwani Kumar Kedia)
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 3
PRINCIPAL’S CERTIFICATE
This is to certify that this report is the result of Project “Computation of Economic
Value Added (EVA) of Sample Companies” undergone by Mr. Ashwani Kumar Kedia
bearing the register number 05XQCM6013 under the guidance and supervision of Dr. N.
S. Malavalli, M.P. Birla Institute of Management. This has not formed a basis for the
award of any Degree/ Diploma of any University.
Date: Dr Nagesh. Malavalli
Place: Bangalore (Principal)
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 4
GUIDE’S CERTIFICATE
This is to certify that this report is the result of Project “Computation of Economic
Value Added (EVA) of Sample Companies” undergone by Mr. Ashwani Kumar Kedia,
bearing the register number 05XQCM6013 is a bonafied work done carried under my
guidance and supervision during the academic year 2005-2007 in the partial fulfillment of
the requirement for the award of MBA degree by Bangalore University. To the best of
my knowledge this report has not formed the basis for the award of any other degree.
Date: Dr. N. S. Malavalli
Place: Bangalore (Principal)
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 5
ACKNOWLEDGEMENT
The research work which I had done gave me enormous amount of knowledge and the
understanding of various financial issues related to the firm’s Computation of EVA. This
research project work is made successful by the combining efforts of a no. of officials
and bears the imprint of many people. This project can not be said completed unless and
until, I fulfill my duty of thanking those persons to whom I deeply indebted. I wish to
express my deep gratitude towards them to their whole hearted support and existence.
Firstly I would like to thank Dr. N. S. Malavalli, principal, M P Birla Institute of
Management, Bangalore, who has given his valuable support and guidance in carrying
out this project work.
I am also extremely thankful to Dr. T. V. N. Rao, Professor, M P Birla Institute of
Management, Bangalore, who has guided me to do this project by giving valuable
suggestion and advice.
Further, I am grateful to Professor Santhanam, Professor, M P Birla Institute of
Management, Bangalore, who gave his suggestions to improve the accuracy and the
dependability of the data.
They all guided me during the period and helped me in each and every step to prepare
this report.
DATE: Ashwani Kumar Kedia
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 6
-CONTENTS- Particulars Page No. 1) Chapter – 1
Abstract 08
Introduction 09
Problem Statement 11
Research Objective 11
Background of EVA 12
2) Chapter – 2 REVIEW OF LITERATURE 16
3. Chapter – 3 METHODOLOGY 19
4. Chapter – 4 DATA ANALYSIS 23
5. Chapter – 5 DISCUSSION & CONCLUSION 34
6. Chapter – 6 BIBLIOGRAPHY & REFERENCES 37
7. Chapter – 7 ANNEXURE 46
TABLES Beta of Sample companies 24
NOPAT Sample companies 25
Capital Employed of Sample Companies 26
WACC of Sample Companies 27 EVA of Sample Companies 29
EVA and Adjusted Market price 31
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 7
Chapter-1
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 8
ABSTRACT
The value-based management performance measure EVA introduced by Stern Stewart &
Co. is an incarnation of the underlying residual income (RI) concept. The concept is
evaluated and compared with traditional profitability measures within a controlled
simulation framework. It is observed that EVA is very sensitive to its cost of equity
component, but it is unexpectedly insensitive to its cost of debt component under regular
conditions. EVA and its variability are observed to be strongly affected by the firm's
growth policies because of leverage effects. EVA is observed to be much more unstable
than the traditional return on investment and directly related to the return on equity
measure. Methodologically, the paper demonstrates the advantages of using a controlled
simulation approach in financial research.
The EVA is computed of 20 companies of the NIFTY for a period of 5 years beginning
from FY 2001-02 to FY 2005-06. EVA is equal to NOPAT (Net Operating Profit) minus
WACC (Weighted Average Cost of Capital). NOPAT is EBIT after taxes. Cost of equity
is calculated using CAPM Model. Beta is calculated based on monthly high low average
of past three years.
From the study it is observed that there is no strong pattern of wealth created by
companies. EVA of different companies varies year to year based on its overall cost of
capital and cost of equity is more influential factor. It is also found that EVA and market
price has no good relation for the sample companies. And thus we can say that investors
do not consider EVA for the investment decision.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 9
INTRODUCTION
With increasing pressure on firms to deliver shareholder value, there has been a renewed
emphasis on devising measures of corporate financial performance and incentive
compensation plans that encourage managers to increase shareholder wealth. One
professedly recent innovation in the field of internal and external performance
measurement is a trade-marked variant of residual income known as economic value-
added (EVA). Economic Value Added (EVA) is a value-based framework that provides a unique insight
into value creation and unites the finance theory with the competitive strategy
framework. Economic Value Added (EVA) is a relatively new concept in the area of
financial management. It is the financial performance measure that comes closest than
any other to capture the true economic profit of a firm. EVA is the performance measure
most directly linked to the creation of shareholder wealth over time. It is a value-based
framework that provides a unique insight into value creation and unites the finance theory
with the competitive strategy framework. The financial concept underlying EVA was
originally propagated by Adam Smith, who proclaimed that the social mission of an
individual enterprise is to maximize the value of shareholders. Further contributions were
made by Merton Miller and Stern Stewart.
Stern Stewart developed EVA to help managers incorporate two basic principles of
finance into their decision making: One, the primary objective of maximizing the wealth
of its shareholders; and two, accepting that the value of a company depends on the extent
to which investors expect future profits to exceed or fall short of the cost of capital.
EVA is the net operating profit minus an appropriate charge for the opportunity cost of
all capital invested in an enterprise. Hence, EVA is an estimate of true economic profit,
or the amount by which earnings exceed or fall short of the required minimum rate of
return those shareholders and lenders could get by investing in other securities of
comparable risk. Jenson (1986) argues that managers do not like to disburse free cash to
investors even when no positive present value project is available.
Capital charge is the most important characteristic of EVA. Under conventional
accounting, most companies seem profitable while, in fact, they may not be. By taking all
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 10
capital costs into account, including the cost of equity, EVA shows the amount of wealth
in rupee a business has created or destroyed in each reporting period. In other words,
EVA is the profit as defined by the shareholders.
A sustained increase in EVA will bring an increase in the market value of a company.
EVA has the advantage of being conceptually simple and easy to explain, since it starts
with familiar operating profits and deducts a charge for the capital invested in the
company. By assessing a charge for using capital, EVA makes managers care about
managing assets as well as income and helps them properly assess the trade-offs between
the two.
Above all, EVA helps in overcoming the ambiguity of financial goals. Most companies
use a plethora of measures to express their financial goals and objectives. Strategic plans
often are based on growth in revenue or market share. Companies usually evaluate
individual products or lines of business on the basis of gross margins. Business units may
be evaluated in terms of return on assets.
Finance departments usually analyze capital investments in terms of the net present
value, but weigh prospective acquisitions against the likely contribution to the earnings
growth. The result of the inconsistent standards, goals and terminology usually results in
cohesive planning, operating strategy and decision making. EVA eliminates this
perplexity by using a single financial measure that links decision making with a common
focus.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 11
PROBLEM STATEMENT
Investors who have a variety of options will evaluate the performance of various
companies based on the returns they provide, before making investments. In this context,
it is relevant to see whether companies are earning returns on their costs, and thereby,
creating wealth for their shareholders.
NEED AND IMPORTANCE OF THE STUDY: Investors who have a variety of options will evaluate the performance of companies
based on the returns they provide, before making investments. Companied need to
improve their financial performance to meet the expectations of investors. So, creation of
wealth is an important task for companies. Non-creation of EVA leads to investor
dissatisfaction. This will affect the equity mobilization activities of companies, which
have a great impact on the economy.
In this context, it is relevant to see whether companies are earning returns on their costs,
and thereby, creating wealth for their shareholders.
THE OBJECTIVE THE STUDY:
To measure the economic value added of selected companies
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 12
THE BACKGROUND OF EVA
EVA is not a new discovery. An accounting performance measure called residual income
is defined to be operating profit subtracted with capital charge. EVA is thus one variation
of residual income with adjustments to how one calculates income and capital. According
to Wallace (1997, p.1) one of the earliest to mention the residual income concept was
Alfred Marshall in 1890. Marshall defined economic profit as total net gains less the
interest on invested capital at the current rate. According to Dodd & Chen (1996, p.27)
the idea of residual income appeared first in accounting theory literature early in this
century by e.g. Church in 1917 and by Scovell in 1924 and appeared in management
accounting literature in the 1960s. Also Finnish academics and financial press discussed
the concept as early as in the 1970s. It was defined as a good way to complement ROI-
control (Virtanen 1975, p.111). Knowing this background many academics have been
wondering about the big publicity and praise that has surrounded EVA in the recent
years. The EVA-concept is often called Economic Profit (EP) in order to avoid problems
caused by the trademarking. On the other hand the name "EVA" is so popular and well
known that often all residual income concepts are often called EVA although they do not
include even the main elements defined by Stern Stewart & Co. For example, hardly any
of those Finnish companies that have adopted EVA calculate rate of return based on the
beginning capital as Stewart has defined it, because average capital is in practice a better
estimate of the capital employed. So they do not actually use EVA but other residual
income measure. This insignificance detail is ignored later on in order to avoid more
serious misconceptions. It is justified to say that the EVA concept Finnish companies are
using corresponds virtually the EVA defined by Stern Stewart & Co.
In the 1970s or earlier residual income did not got wide publicity and it did not end up to
be the prime performance measure in great deal of companies. However EVA, practically
the same concept with a different name, has done it in the recent years. Furthermore the
spreading of EVA and other residual income measures does not look to be on a
weakening trend. On the contrary the number of companies adopting EVA is increasing
rapidly. We can only guess why residual income did never gain a popularity of this scale.
One of the possible reasons is that Economic value added (EVA) was marketed with a
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 13
concept of Market value added (MVA) and it did offer a theoretically sound link to
market valuations. In the times when investors demand focus on Shareholder value issues
this was a good bite EVA measures whether the operating profit is enough compared to
the total costs of capital employed. Stewart defined EVA (1990, p.137) as Net operating
profit after taxes (NOPAT) subtracted with a capital charge.
At operational level this new approach leads often to increased shareholder value through
increased capital turnover (Wallace 1997, p.16). In many companies everything has been
done in cutting costs but the capital efficiency has been ignored. EVA has been helpful
because it forces to pay attention to capital employed and especially to excess working
capital. Allocating the capital costs to their originators i.e. individual functions of
organization can further reinforce this impact.
One of EVA's most powerful features is its suitability to management bonus systems.
This have been empirically proofed to be good way to increase shareholder value
(Wallace 1997). The good feasibility for this purpose is due to the nature of EVA as
excess return to shareholders. When EVA is maximized also shareholder value is
maximized. The idea of EVA bonuses is that if management can be paid some bonuses,
the shareholders have always earned higher return on their capital than they can expect.
This kind of bonus system is usually beneficial both to management and the shareholders,
because the performance level is likely to rise after introducing EVA bonus system. EVA
bonus paid is far from a cost to shareholders, because it is often a share in the
discretionary value created. With well designed bonus plan, the higher the bonuses that
are paid, the better it is for the shareholders. In order to be successful, EVA based bonus
systems should be long-term, based mainly on changes of EVA and offer considerable
bonuses for considerable shareholder value improvements.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 14
With implementation it is important to understand the EVA-concept thoroughly and tailor
the concept to the unique situation of each company or business unit. EVA is at its best as
an overall measure and organizational approach with strong link to payroll of managers
and other employees. That kind utilization can not succeed without deep understanding
and commitment achieved with proper training.
EVA = NOPAT – CAPITAL COST
EVA = NOPAT – COST OF CAPITAL x CAPITAL EMPLOYED
Terminology
Shareholder value = Shareholder value is being used as a overall term covering various
aspects in thinking that promotes the interests of shareholders. Normally the term also
means a company’s value to its shareholders i.e. market capitalization.
Shareholder value approach = Shareholder value approach refers to the focus of
organization and management on acting within the interests of shareholders. Hence it
means focus on maximizing the wealth of shareholders (creating shareholder value).
Value based measures = Value based measures are new performance measures that
originate from the shareholder value approach. They seek to measure the periodic
performance in terms of shareholder value created (or destroyed).
Cost of Equity: Cost of equity is the minimum rate of return, which has to be made from
an equity-financed project, in order to maintain the present wealth of the shareholders
unaffected. It can be computed based on Capital Asset Pricing Model (CAPM).
According to CAPM,
Cost of Equity Ke = Risk-free Rate + (Beta x Market Premium).
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 15
Risk-free Rate: Risk-free rate is the rate of return from securities, which are free from
any type of risk. Generally, government-backed securities are considered as risk-free
securities. So, the yield on the 364-day Government of India Treasury Bill is considered
as risk-free rate [Thampy et al. (2001), Sen et al. (2003)]. Theses show 9.7583%,
7.1016% and 5.9251% for years 2000-01, 2001-02 and 2002-03 respectively.
Beta: Beta is the measure of the volatility of a stock in relation to the market. It is the
index of systematic risk. Beta for the each stock was calculated based on the daily stock
price with the Bombay Stock Exchange’s sensex returns as the proxy for the market
returns. Beta was calculated by using the data from the period April 1, 2002 to March 31,
2003.
Market Premium: Market premium is the excess return offered by the market over the
risk-free rate. It is considered as 7%, since some of the leading firms like Infosys used the
same rate while calculating EVA for their firm.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 16
Chapter-2
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 17
LITERATURE REVIEW:
Stern Stewart (1990, p.215 - 218) has first studied this relationship with market data of
618 U.S. companies. Stewart presents the results in his book "The quest for value".
Stewart has studied the relationship between EVA and market value of the company and
he has produced a list of companies’ EVA annually since 1982, its coverage is limited to
the largest 1,000 companies. He states that EVA and MVA correspond each other in
reality quite well among US companies (the data was from late 1980’s). Only the
relationship between negative EVA and negative MVA does not hold very well.
According to Stewart, this is because the potential of liquidation, recovery,
recapitalization, or takeover sets a floor on a company’s market value (Stewart p.217).
For example with companies which have a lot of fixed assets this is quite easy to
understand. Market value will always reflect the value of assets even though the company
has very low or negative rate of return (and so theoretically it should sell a lot below
book value). That is because the company can always be liquidated; the owners have an
option to liquidate the assets if the return looks week also in the future. On the other hand
markets do not believe that the weak returns can go on forever. Markets are expecting a
chance, an improvement, in the long run. If EVA is positive, the relationship is more
direct. Then the market valuation happens on the basis of return and growth potential and
not on the basis of liquidation or recovery value. Stewart finds also that MVA and EVA
correspond each other best when we talk about changes in EVA and MVA and not the
absolute levels. Changes in EVA and MVA are not affected so much by accounting
distortions and inflation than the absolute values.
Grant (1996) shows that EVA significantly impacts the market value added of a firm and
that this wealth effect stems from the company’s positive residual return on capital. He
calculates regression statistics between the MVA-to-capital and EVA-to-capital ratios
from the data of 983 firms.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 18
Peterson (1996) show that value-added measures are slightly but not significantly more
correlated with stock returns than traditional performance measures.
Lehn and Makhija (1996) study EVA and MVA as performance measures and signals for
strategic change. Their data consists of 241 U.S. companies and cover years 1987, 1988,
1992 and 1993. The researchers first find out that both measures correlate positively with
stock returns and that the correlation is slightly better than with traditional performance
measures like return on assets (ROA), return on equity (ROE) and return on sales (ROS).
Additionally they study how companies’ performance, as measured in terms of EVA and
MVA, affect on the CEO firings. Finally they examine the relationship between
EVA/MVA and corporate focus. Lehn and Makhija find an inverse relation between
EVA/MVA and abnormal CEO turnover. They also find that firms with greater focus on
their business activities have significantly higher MVA than their less focused
counterparts. Lehn and Makhija conclude that their results suggest EVA and MVA to be
effective performance measures that contain information about the quality of strategic
decisions and serve as signals of strategic change.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 19
Chapter-3
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 20
METHODOLOGY STUDY TYPE: The study type is analytical, quantitative and historical.
Analytical as facts and existing information is used for the analysis.
Quantitative as EVA is calculated and the variables are expressed in measurable terms.
Historical as the historical information is used for analysis and interpretation.
SAMPLE TECHNIQUE: The Sampling method used here is Non-Probability Sampling. Companies listed in the
stock exchange are considered for the sample because market prices and other
information are available. Since NIFTY is a good proxy for the whole market, so
companies will be selected from the NIFTY Index.
SAMPLE SIZE: Sample includes 20 companies in the NIFTY (for which relevant data was available), for
a period of 5 years starting from FY 2001-02 to FY 2005-06. The following are the
sample 20 companies:
1. Associated Cement Companies Ltd.
2. Bajaj Auto
3. Bharat Heavy Electricals Ltd.
4. Bharat Petroleum Corporation Ltd.
5. Cipla Ltd.
6. Dabur
7. Dr. Reddy’s Laboratories Ltd.
8. Hero Honda Motors
9. Hindustan Lever Ltd.
10. ITC Ltd.
11. Infosys Technologies Ltd.
12. Larsen & Tourbo Ltd.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 21
13. Maruti Udyog
14. Oil & Natural Gas Corporation
15. Ranbaxy Laboratories Ltd.
16. Reliance Industries
17. Satyam Computers
18. Tata Consultancy Services
19. Tata Motors
20. Wipro Ltd.
DATA COLLECTION:
Data type: Secondary data
Data Content: Historical share prices of the sample companies.
Index values of S&P CNX 500.
Financial Information of the sample companies.
Data Source: Historical share prices of the sample companies and the index points for the period has
been taken from the database of Capital Market Publishers (India) Ltd., Capitaline 2000
as well as from nseindia.com. Financial statements of the sample companies have also
been taken from the same source.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 22
METHOD ADOPTED TO CALCULATE ECONOMIC VALUE ADDED (EVA):
EVA = NOPAT-WACC*CAPITAL EMPLOYED
NOPAT is net operating profit after taxes.
WACC is weighted average cost of capital (equity and debt). WACC used in the
calculations is at book value of equity and debt. It is calculated as follows:
WACC = Ke *W1+ Kd (1-T)*W2
W1 is weight of EQUITY
W2 is weight of DEBT
Kd is the effective cost of Debt, which is calculated by dividing the totat
interest by the total debt.
Ke is calculated using the Capital Asset Pricing Model developed by Modigliani and
Miller.
Ke=Rf+Beta (Rm-Rf)
Rf is the risk free rate, i.e., the rate of interest for 1-year government
securities. These rates are obtained from the website of Reserve Bank
of India.
Rm is the return for the market. It is calculated by using the formula given below for the
index values.
Rm=Average of return on market for all the 10 years
Return = Closing index value-opening index value * 100/Opening index value
Beta values for all the sample companies for all the 5 years are calculated by finding the
slope between log normal of share prices of all the companies and log normal of the
index values. Log normal of the values is considered to remove abnormalities if any and
convert them into normal distribution.
Invested Capital is the total long term funds and includes equity shares and the total debt
as at the end of the year.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 23
Chapter-4
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 24
DATA ANALYSIS AND INTERPRETATION
TABLE-1
The following table shows the calculated beta of sample companies for
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 33
INTERPRATION:
From the table it can be understood that there is no such relationship
between price and EVA. Because increase or decrease in EVA, there is no
relative effect on market price of shares of companies. Market price does not
vary with the variation of economic value added of the companies.
Especially in 2004 and 2006 when companies did not created any wealth to
its shareholders, market price of the companies was not influenced
negatively.
Market price of Infosys has increased consistently in stead of negative EVA
in 2006. Price of Wipro and Satyam is also increased consistently in stead of
negative EVA in 2004 and 2006.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 34
Chapter-5
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 35
DISCUSSIONS:
Economic Value Added is a residual income variable. It is defined as Net
operating profit after taxes subtracted with the cost of capital tied in operations.
EVA seems to have importance for companies as a performance measurement
and controlling tool. First of all it is fairly simple measure but still measures well
the ultimate aim of any given company, the increase or decrease in shareholders’
wealth. Maximizing traditional performance measures like ROI is not theoretically
in line with maximizing the wealth of shareholders. Therefore EVA is superior to
conventional performance measures. The premise behind EVA – that businesses
must cover their capital costs – is neither new nor peculiar. Putting it into practice
can still be eye-opening. EVA shows financial performance with a new pair of
glasses or offers new approach especially for the companies where equity is
viewed as free source of funds and performance is measured by some earnings
figure. At best EVA helps with creating a mind-set throughout the organization
that encourages managers and employees to think and behave like owners.
Substantial shareholder value increases and true success stories arise always
from outstanding strategy, quick response, great ideas and good predicting of
future. EVA helps in quantitative assessing of different strategies but that is all.
Wealth does not arise from EVA alone. EVA only measures changes of wealth. It
is also as short-term as all other periodic performance measures. Therefore all
companies should rely also on other performance measures. Especially
important this is e.g. for new growth phase companies. However we have to bear
in mind that the success or failure of any given company is measured ultimately
as created shareholder value. Therefore EVA is important measure also for those
companies that use primarily other tools is assessing the achievement of their
strategic goals.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 36
Conclusion The above discussion explains the importance of using EVA as a tool for
measuring financial performance. The study reveals that there is no strong
pattern of EVA of selected companies during the period. The wealth created by
most companies in year 2004 and 2006 is negative because of higher cost of
capital than that of other years.
The central idea of EVA is subtracting the cost of capital from the firm's profits to
measure, as the term indicates, the economic additional value produced by the
firm to its owners over the weighted cost of the capital employed. This raised the
question of the effect of the debt and equity cost components on the behavior of
EVA. It was observed that the cost of debt has little effect on the EVA's. On the
other hand, as is expected, EVA behaves in a linear fashion with respect to the
cost of equity. It was also observed that even EVA is much more unstable than
the other performance measure.
It is also observed that there is no strong relation between EVA and market
prices of the companies. Thus, it can be understood that investor do not give so
importance to EVA for its investment decision. Extensive study is required to
establish the influence of other factors like non-fund based income, spread,
deployment of funds, market price, etc. It is also expected that the usage of EVA
as a financial performance tool will also be more in India.
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 37
Chapter-6
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 38
BIBLIOGRAPHY: TEXT BOOKS: Financial Management, Theory and Practice Prasanna Chandra (Sixth Edition) Research Methodology Donald Cooper and Pamela Schindler (Eighth Edition) WEBSITES: www.nseindia.com www.rbi.org.in www.capitaline.com www.investopedia.com
Computation of Economic Value Added (EVA) of Sample Companies
M P Birla Institute of Management, Bangalore 39
REFERENCES: 1. ARTICLES OF ICFAI (The Institute of Chartered Financial Analysts of India): “Computation of EVA in Indian Banks”, by Roji George, the ICFAI Journal of Bank Management, Vol IV, No. 2 , May 2005, Pg No. 30-44.
2. A Review and Synthesis of the Economic Value-Added Literature, Andrew Worthington, Tracey West