ECONOMIC VALUE ADDED

1. ECONOMIC VALUE ADDED WELCOME P.RAJU IYER

2. Overview EVA MVA Value Based Management & Business Strategy Drivers of Shareholders Value Linking VBM to Business Strategy Keys to Success

3. EVA focuses on Economic Income – the income generated by the company net of the investors’ required return on capital investedPopular measure being used by several firms to determine whether an existing proposed investments positively contributes to the Owners’ / Shareholders wealth

4. EVA is equal to after-tax operating profits of a firm less the cost of funds used to finance the investments. • Combines the accounting and finance frameworks for measuring corporate finance • In other words a firm adds value for its shareholders, if its return on capital exceeds its cost of capital. EVA is equal to after-tax operating profits of a firm less the cost of funds used to finance the investments. EVA is equal to after-tax operating profits of a firm less the cost of funds used to finance the investments.

5. EVA • Capital is the amount of cash invested in business, net of depreciation. It can be calculated as the sum of interest-bearing debt and equity or as the sum of net assets less non-interest bearing current liabilities. • NOPAT is profits, derived from the firm’s operations, after tax but before financing costs non-cash expenses.

6. To determine the EVA adjustments has to be effected on the published accounts – from the investors point of view traditional calculation of the return on capital is distorted due to accounting conventions 1. Calculate the adjusted capital employed – Equity and Debt + adjustment for items such as cumulative good will associated with acquisition - adjust for amounts charged to Reserves unless the underlying economic value has reduced, R & D expenditure to be treated as capital investment as they will produce revenues in future.

7. 2.   Calculate Net Operating Profit after Tax (NOPAT). 3.     Calculate the company’s Weighted Average Cost of Capital – (WACC). 4.     Multiply the cost of capital by the capital employed to produce a capital charge which is then deducted from the company’s profit. The positive result indicates that organization is adding EVA for the shareholders

8. This approach is attractive where substantial assets are tied up in projects,because it simplifies the process of value creation to one or more of a few actions.

9. Increasing the operating income from assets in place by reducing costs or increasing sales. Reducing the cost of capital by changing the financing mix. Reducing the amount of capital tied up in existing projects, without affecting operating operating income significantly, by reducing working capital investment and selling unutilized or underutilized assets.

10. Limitations Does not account for real options (growth opportunities) inherent investment decisions, especially in R & D, whereas a firm’s market value does take this into account. Therefore, growth in EVA becomes more relevant. For firms with fewer assets is place and large growth opportunities, EVA is not likely to explain the changes in market prices.

11. MARKET VALUE ADDED An External Measure of how much better off the shareholders as a consequence of management’s performance. MVA seeks to reflect the decisions of the present management team or the period of a major business decision such as an acquisition takes place. MVA = Rise in Market Capitalization during the period - Increase in capital invested during the period

12. VALUE BASED MANAGEMENT A Methodology that involves managing all aspects of the business in accordance with the desire to create and maximize the wealth of shareholders. Growing concern about the diverse of ownership from control Adoption of VBM techniques by investment analysis Emergence of aggressive shareholders Problems assessing the impact of new management techniques Marketing efforts of management consultants

13. Areas covered by VBM • Strategy Selection • Resource Allocation • Target Setting and Performance Measurement • Managerial Reward Schemes • Value Reduction • Implementation

14. DRIVERS OF SHAREHOLDERS VALUE Business Value = Present Value of free cash flow from operations plus value of marketable securities The amount of cash it is generating which could potentially become dividend and will be the basis of the market capitalization of the business. The securities or investment held by the company which could be disposed of for cash without affecting operations.

15. The corporations overall value is arrived by Shareholders Value = Business Value - Debt Value

16. To Increase shareholder value, the Management should increase Business Value or reduce Debt. • Sale Growth Rate • Operating Profit Margin • Cash income tax rate • Incremental fixed capital investment rate • Investment in working capital rate • Planning Period • Cost of Capital

17. LINKING VBM TO BUSINESS STRATEGY EVA ignores future forecast earnings. Other approaches to VBM take future earnings into consideration on the grounds that the perceptions investors hold of future earnings will influence the share price and hence MVA. Market Expectations of future earnings

18. Investor understanding of firm’s strategy Investor trust in ability of firm to deliver its strategy Number of years over which earnings are forecast Size of forecast earnings

19. Length of time horizon of strategy Quality of strategic forecasts Past experience of firm’s ability to implement strategy Extent of investor understanding of strategy Achievement and publications of KPIs Quality of investor relations

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