Economic Value Added

(EVA)
Presented by:
NEEL
BHAVIK
AMIT

VINIT

Introduction of EVA

EVA was developed by a New York consulting firm, Stern

Steward & Co. in 1982 to promote value-maximisig
behaviour in corporate managers.

Value-based measure to evaluate business strategies,

capital projects and to maximise long-term shareholders
wealth.

EVA sets managerial performance target and links it to

reward systems.

Unlike simple traditional budgeting. EVA focuses on ends

and not means.

Definition for EVA

EVA is defined as net profit after taxes and after the cost of
capital.
FORMUALE for EVA

EVA

Net operating profit

Taxes

Cost of capital

Calculating Net Operating After Tax

(NOPAT)
NOPAT is easy to calculate. From the income statement we
take the operating incomes and subtract taxes.
e.g. XYZ Company

Particulars
Sales

Amount (Rs.)
24,36,000/-

Cost of Goods sold (-)

17,00,000/-

Gross Profit

7,36,000/-

Selling, general & Admin 4,00,000/Exp. (-)

Operating Profit

3,36,000/-

Taxes (-)

1,34,000/-

NOPAT

2,02,000/-

Cost of Capital
Meaning: The cost of capital is the rate of return required by
the shareholders and lenders to finance the operations of the
business.
Types of Cost of Capital
Equity Capital: Equity Capital is provided by the Shareholders.
Borrowed Capital: It is the Capital borrowed by the company
from Banks and other Financial Institutes.

Weighted Average Cost of Capital

(WACC)
Weighted Average Cost of Capital examines the various
components of the Capital structure and applies the
weighting factor of after-tax cost to determine the cost of
Capital.
Calculating WACC
e.g. XYZ Company

Particulars

Amount (Rs.)

Long Term Debt

5,00,000/-

Preferred Stockholders Equity

2,00,000/-

Total Common Equity

7,00,000/-

Total Capital

14,00,000/-

WACC Continue

Long Term Debt

Bond Cost

Bond

Rs. 100/-

Net Return (Deducting discounting & Financing cost)

Rs. 96/-

Interest

14%

(Rs. 14/-)

Assumed Tax

35%

(Rs. 5/-)

Interest After Tax

(Rs.14 Rs. 5)

Cost for Bond Financing

(9/96 x 100)

9%
9.47%

WACC Continue

Preferred Stock Cost

Preference Share (Per share)

Net Revenue (Deducting discount & financing cost)

Rs. 100/Rs. 98/-

Dividend
Cost for Preferred Share

11% (Rs. 11/-)

11.2%

(11/98 x 100)

WACC Continue

Common Equity Cost

Share Price

Rs. 100/-

(Per Share)

Net Return (Less issuing cost)

EPS (Estimated by investors & reliable analyst)

Rs. 85/Rs. 12/-

Cost for Common Equity

14.1%

(12/85 x 100)

WACC Continue

Summarizing

Bond Cost

9.47%

Preferred Stock Cost

11.2%

Common Equity Cost

14.1%

Calculation of WACC
for XYZ Company
Particulars
Long Term Debt

Amount
(Rs.)
5,00,000/-

Cost
(%)
9.47

Total
(Rs.)
47,375/-

Preferred Stock Cost

2,00,000/-

11.2

22,400/-

Common Equity Cost

7,00,000/-

14.1

98,700/-

Total Capital

14,00,000/-

1,68,475/-

The total Weighted Average Cost of Capital (WACC) =

1,68,478 / 14,00,000 = 12.03%

Calculation of EVA
for XYZ Company
NOPAT

Rs. 2,02,000/-

Capital Employed

Rs. 15,00,000/-

(Including Rs.1,00,000/- Reserve & Surplus)

Cost of Capital
Capital Charge

12.03%
(12.03/100 x Rs. 15,00,000/-)

Economic Value Added (EVA)

(Rs. 2,02,000 Rs. 1,80,450)

Rs. 1,80,450/Rs. 21,550/-

Strategies for Increasing EVA

Increase the return on existing projects (improve operating
performance).
Invest in new projects that have a return greater than the cost
of capital.
Use less capital to achieve the same return.
Reduce the cost of capital.
Liquidate capital or curtail further investment in sub-standard
operations where inadequate returns are being earned.

Advantages of EVA
EVA provides for better assessment of decisions that affect
balance sheet and income statement or tradeoffs between
each through the use of the capital charge against NOPAT.
EVA decouples bonus plans from budgetary targets.
EVA covers all aspects of the business cycle.
EVA aligns and speeds decision making, and enhances
communication and teamwork.

Limitations of EVA
EVA does not control for size differences across plants or
divisions.
EVA is based on financial accounting methods that can be
manipulated by managers .

EVA may focus on immediate results which diminishes

innovation.
EVA provides information that is obvious but offers no
solutions in much the same way as historical financial
statement do.

Conclusion
As a performance measure, Economic Value Added forces the
organization to make the creation of shareholder value the
number one priority. EVA is changing the way managers run
their businesses. When business decisions are aligned with the
interest of the shareholders, it is only a matter of time before
these efforts are reflected in a higher stock price.