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Economic Value Added (EVA) Concept: By: Anu Devassy

Economic Value Added (EVA) is a value-based performance measure developed in 1982 to promote value-maximizing behavior. [1] EVA establishes clear links between economic return, accounting returns, and shareholder returns. [2] It measures whether a company is creating or destroying shareholder value by looking at net operating profit after tax compared to the cost of capital. [3] Companies can increase EVA by improving returns on existing capital, investing in new projects with returns above the cost of capital, using less capital for the same returns, or reducing the cost of capital. While EVA is a comprehensive performance metric, it also has limitations such as complexity, susceptibility to manipulation, and bias against new assets.

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106 views

Economic Value Added (EVA) Concept: By: Anu Devassy

Economic Value Added (EVA) is a value-based performance measure developed in 1982 to promote value-maximizing behavior. [1] EVA establishes clear links between economic return, accounting returns, and shareholder returns. [2] It measures whether a company is creating or destroying shareholder value by looking at net operating profit after tax compared to the cost of capital. [3] Companies can increase EVA by improving returns on existing capital, investing in new projects with returns above the cost of capital, using less capital for the same returns, or reducing the cost of capital. While EVA is a comprehensive performance metric, it also has limitations such as complexity, susceptibility to manipulation, and bias against new assets.

Uploaded by

Anu Devassy
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Economic Value Added (EVA)

Concept

BY : ANU DEVASSY

1
Background of EVA
• New Value based performance measure
developed by a New York Consulting
firm, Stern Steward & Co in 1982

• The object of EVA is to promote value-


maximizing behavior in corporate
managers
What is EVA
• EVA is single, value based measure
that was intended to evaluate

– Business strategies

– Capital projects

– Maximizing the long-term shareholders


wealth
What is EVA (contd..)
• EVA establishes clear and Shareholders Returns
accountable links among

– Economic Return:
strategic thinking, capital
investment
EVA
– Accounting Returns:
operating decisions and
Accounting Economic
– Shareholders Returns: returns Returns
shareholder value
Why EVA

• EVA sets managerial performance


target and links it to reward system
which motivates the managers to
behave like owners.

• EVA allow managers to have discretion


and free range creativity keeping the
long term object in mind.
EVA Concept of Profitability

• A successful firm should earn atleast its cost of


capital.
• Firms that earn positive/higher returns than
financing costs benefit shareholders and
enhance shareholder value.

“Until a business returns a profit that is greater


than its cost of capital, it operates at a loss”
– Peter F Drucker in an article in Harward Business Review
Composition & Mechanics of EVA
• EVA represents Net operating profit after tax
(NOPAT)
MINUS
• Cost of Capital employed to generate the operating
profits.
Object of EVA is to know

• Whether the Entrepreneurs are really increasing


the Net Worth of the Organization or they are
destroying it gradually

• The Real growth Entrepreneurs have added to


the Shareholders’ Wealth.
Concept of EVA

Shareholders’ Value is created by


MAXIMIZING

“ECONOMIC PROFITS”
What it measures
• Creating value
– The Company which earns Higher
Returns (Net Operating Profit After
Tax) than the Cost of Capital

ARE CONSIDERED AS
HAS “CREATED THE VALUE”
What it measures cont..
• Destroying value
– The company which earns Lower
Return (Net Operating Profit After Tax)
than the Cost of Capital

ARE CONSIDERED AS
Destroyers of Shareholders’ Value
Strategies for increasing EVA

• Increase the return on existing projects


(improve operating performance)
• Invest in new projects that have a return greater
that 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.
• Hence in the EVA there are three way to
increase value
– Operate: Improve the return earned on existing
capital
– Build: Invest as long as returns exceeds cost of
capital
– Optimize: Reduce cost of capital by optimizing
capital structure
Performance
Goal Setting Measurement
Financial
Planning
Shareholder
Communication
Incentive
Compensation

Capital
Budgeting

EVA
Advantages of EVA
• EVA is more than performance management,.
It is motivational, compensation based
management system that facilities economic
activity and accountability at all levels in the
firm.
Limitations of EVA
• EVA is based on financial accounting methods that can be
manipulated by managers by using different method of accounting.
– There are different ways to calculate NOPAT and COC as there are
numerous fundamental differences exist with regard to calculation of
NOPAT and COC
– There are 164 adjustment which is really cumbersome exercise
– EVA may focus on immediate results which diminishes innovation
• EVA is biased against new assets
• EVA is in favour of large companies
• EVA favours more debt compared to equity
• It is difficult to implement
• Implementation includes significant cost
• EVA does not study business drivers like consumer satisfaction or
learning and growth.
List of few Companies in India
implementing EVA and its objective

• INFOSYS -

• MARICO -
• DR. REDDY’S LABORATORIES -
• TCS -
• Godrej -
Why EVA is implemented by only
few companies
• Implementation of EVA is costly affair
• The process is challenging and time consuming and too
complicated for small business
• Especially the key persons (Top and middle managers) have
to understand and commit to EVA thoroughly which is
difficult
• Switching over to EVA from the earlier traditional methods of
bonus system may create resistance in the employees
• EVA does not have system of Minimum and maximum cap
for bonus as the traditional methods have.
Thanks

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