Net Economic

Value Added from

Year to Year
Group 7
Avelino, Brosas, Castillano, Casulla, Duela
Economic Value Added (EVA)

Economic Value Added (EVA) or Economic Profit is a measure

based on residual income technique.

EVA represents the idea that:

Real value is created when additional return are generated

for shareholders above their required rate of return

Projects should create returns above their cost of capital

EVA Formula

CAPITAL
EVA = NOPAT - WACC x INVESTED

Where:
NOPAT = Net Operating Profits After Tax
WACC = Weighted Average Cost of Capital
Capital Invested = Equity + long-term debt at the beginning of the period

Note: WACC x Capital Invested is also known as Finance Charge

Calculating Net Operating After Tax (NOPAT)
PARTICULARS AMOUNT

SALES 24, 360, 000

COST OF GOODS SOLD (-) 17,000,000

GROSS PROFIT 7,360,000

SELLING, GENERAL & ADMIN EXP. (-) 4,000,000

OPERATING PROFIT 3,360,000

TAXES (-) 1,340,000

NOPAT 2,020,000
Cost of Capital

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)
Examines the various components of the capital structure and
applies the weighting factor of after tax cost to determine the
cost of capital

Higher WACC = higher financial risk and higher costs

Lower WACC = lower risk and lower capital costs
XYZ Company

PARTICULARS AMOUNT

LONG TERM DEBT 5,000,000

PREFERRED STOCKHOLDER’S EQUITY 2,000,000

TOTAL COMMON EQUITY 7,000,000

TOTAL CAPITAL 14,000,000

WACC Long Term Debt

Bond Cost

Bond 1000

Net Return ( deducting discounting and financing cost) 960

Interest 14% (1000 x .14 = 140)

Assumed Tax 35% (140 x .35 = 50)

Interest after Tax (140 - 50) 90%

Cost for Bond Financing (90/960 x 100) 9.37%

WACC Preferred Stock Cost

Preference Shares (per share) 1000

Net revenue ( deducting discount and financing cost) 980

Dividend 11% (1000 x .11 = 110)

Cost for Preferred Share (110/98 x 100) 11.2%

COMMON EQUITY COST

PARTICULARS AMOUNT

Share Price (Per share) 100

Net Return (Less issuing cost) 85

EPS (Estimated by investors & reliable analyst) 12

Cost for common Equity (12/85 x 100) 14.1%

SUMMARIZING

PARTICULARS AMOUNT

Bond Cost 9.47%

Preferred Stock Cost 11.2%

Common Equity Cost 14.1%

Calculation of WACC for XYZ Company

COST
PARTICULARS AMOUNT TOTAL
(%)

LONG TERM DEBT 5,000,000 9.47 47,350,000

PREFERRED STOCK
2,000,000 11.2 22,400,000
COST

COMMON EQUITY
7,000,000 14.1 98,700,000
COST

TOTAL CAPITAL 14,000,000 - 168,450,000

The total Weighted Average Cost of Capital (WACC) =

168,450,000 / 14000,000= 12.03%
Calculation of EVA for XYZ Company

NOPAT 2,020,000

CAPITAL EMPLOYED
15,000,000
(Including 1,000,000- Reserve and Surplus)

COST OF CAPITAL 12.03%

CAPITAL CHARGE
1,804,500
(12.03 / 100 x 15,000,000)

ECONOMIC VALUE ADDED (EVA)

215,500
(2,020,000 - 1,804,500)
STRATEGIES FOR
INCREASING EVA

Improve Invest Use Reduce

Operating Performance New Projects Less Capital the Cost of Capital
ADVANTAGES
OF EVA

Provides for better Decouples bonus plans from Covers all aspects Decision-making,
assessment of decision budgetary targets of the business cycle communication and team work
LIMITATIONS
OF EVA

Based on financial accounting

Does not control Focus Provides information
that can be
for size differences on immediate results but no solutions
manipulated by managers
Thank You