Shantanu's Blog

Database Consultant

December 30, 2003

PC Pitstop Home
Welcome! At PC Pitstop we can help you get your PC in top form -- running fast, stable and secure. PC Pitstop runs diagnostics on your PC to identify things that might help improve performance. The process is fully automated, private and safe. After the diagnostics run, we'll give you tips for improving all kinds of things. Best of all, the service is free!

Journalism for journalists: "The web is the most important tool for freedom of speech since the invention of language. Martin Nisenholtz, CEO of New York Times Digital, tells it like it is."

Economic Value Added (EVA)

Investors use various different valuation tools to assess the attractiveness of stocks. So far, a large number of investors were primarily focussing on the Price/Earnings or the Price/Cash Flow valuation parameters, to pick out stocks. A new approach that investors have now started looking at is the concept of Economic Value Added, popularly known as EVA (tm). Traditional valuation parameters such as Price/Earnings and Price/Cash Flow can be very easily influenced and even manipulated by accounting practices. In addition these approaches are static and do not show whether management has been creating or destroying value.
EVA is defined as Economic Profit or residual income and is simply the operating after tax profit less a charge for that capital.. Representing real profit versus paper profit, EVA underlies shareholder value, increasingly the main target of leading companies' strategy. In essence it therefore is the best valuation parameter that addresses the financial strategy of the firm and the fact whether that strategy is value enhancing or destroying. Shareholders are the players who provide the firm with its capital; they invest only to gain a return on that capital.

Difference between EVA and Traditional methods:

The main differences between EVA and the traditional are as follows:
» Earnings per share alone tell nothing about the cost of generating those profits. In addition the company's earnings could be manipulated by accounting adjustments. It has often been seen that during the time, the company's EPS has been increasing, its EVA has been consistently declining.
» Return on assets is relatively, a more realistic measure of economic performance, but ignores the cost of capital. EVA addresses this inconsistency.

EVA as a Concept
The basic equation for calculating EVA is:
EVA= NOPAT- Cost of Capital
NOPAT: Net Operating Profits After Taxes
This is the operating profit less taxes but before financing costs and non-cash entries (although not depreciation).
Cost of Capital:
This is the charge for the use of capital. It includes interest on the debt and a charge for the equity capital based on a cash equivalent- equity times cost of equity rate.
The idea behind EVA is rooted in economic income as opposed to accounting income. In order to calculate economic income from the accounting income a lot of adjustments need to be made.

Adjustments Required to Calculate NOPAT
+ Increase to Deferred Taxes
+ Increase to LIFO (full form) Reserve
+ Goodwill Amortized in Current year
+ Increase to Net Capitalized Intangibles
+/- Unusual loss or (Gains) net of tax
+ Increase to other Reserves &Allowances
Adjustments Required to Calculate Capital
+ Deferred Taxes
+ LIFO Reserve
+ Total Goodwill Amortized till date
+ Net Capitalized Intangibles
+/- Cumulative loss or (Gains) net of tax
+ Other Reserves &Allowances

Here an attempt is made to calculate earnings that are close to cash and this is compared to a capital base that is expressed in cash equivalent terms.
Market Value = Book Value + Present Value of Future EVA

Using EVA
EVA provides management with three options to create value
* Growth
Invest capital in projects that earn a return higher than the cost of capital.
* Process Improvement
Increase returns through better efficiencies, cost of control and higher productivity.
* Asset Management
Improve the management of assets by selling off non-performing assets and increasing asset efficiency. Improving cash tied up in receivables and inventory would be a basic approach of increasing EVA.
EVA is useful as a valuation tool as it helps to
· Evaluate the true performance of business units and the overallorganization.
· Determine how the stock will perform in the future.
· Trace inconsistencies between the economic and the accounting earnings that cannot be unveiled by the traditional EPS comparisons between companies.

Limitations of EVA:
EVA calculates the economic earnings using the traditional accounting model that is not adjusted for inflation. In itself, EVA is not an absolute measure for the valuation of a company. Any company with a positive EVA could have a declining share of value within the market place and hence may have poor valuations. EVA is a more comprehensive valuation methodology to calculate value and is a step closer in measuring value approximates.


June 2001   July 2001   January 2003   May 2003   September 2003   October 2003   December 2003   January 2004   February 2004   March 2004   April 2004   May 2004   June 2004   July 2004   August 2004   September 2004   October 2004   November 2004   December 2004   January 2005   February 2005   March 2005   April 2005   May 2005   June 2005   July 2005   August 2005   September 2005   October 2005   November 2005   December 2005   January 2006   February 2006   March 2006   April 2006   May 2006   June 2006   July 2006   August 2006   September 2006   October 2006   November 2006   December 2006   January 2007   February 2007   March 2007   April 2007   June 2007   July 2007   August 2007   September 2007   October 2007   November 2007   December 2007   January 2008   February 2008   March 2008   April 2008   July 2008   August 2008   September 2008   October 2008   November 2008   December 2008   January 2009   February 2009   March 2009   April 2009   May 2009   June 2009   July 2009   August 2009   September 2009   October 2009   November 2009   December 2009   January 2010   February 2010   March 2010   April 2010   May 2010   June 2010   July 2010   August 2010   September 2010   October 2010   November 2010   December 2010   January 2011   February 2011   March 2011   April 2011   May 2011   June 2011   July 2011   August 2011   September 2011   October 2011   November 2011   December 2011   January 2012   February 2012   March 2012   April 2012   May 2012   June 2012   July 2012   August 2012   October 2012   November 2012   December 2012   January 2013   February 2013   March 2013   April 2013   May 2013   June 2013   July 2013   September 2013   October 2013   January 2014   March 2014   April 2014   May 2014   July 2014   August 2014   September 2014   October 2014   November 2014   December 2014   January 2015   February 2015   March 2015   April 2015   May 2015   June 2015   July 2015   August 2015   September 2015   January 2016   February 2016   March 2016   April 2016   May 2016   June 2016   July 2016   August 2016   September 2016   October 2016   November 2016   December 2016   January 2017   February 2017   April 2017   May 2017   June 2017   July 2017   August 2017   September 2017   October 2017   November 2017   December 2017   February 2018   March 2018   April 2018   May 2018   June 2018   July 2018   August 2018   September 2018   October 2018   November 2018   December 2018   January 2019   February 2019   March 2019   April 2019   May 2019   July 2019   August 2019   September 2019   October 2019   November 2019   December 2019   January 2020   February 2020   March 2020   April 2020   May 2020   July 2020   August 2020   September 2020   October 2020   December 2020   January 2021   April 2021   May 2021   July 2021   September 2021   March 2022   October 2022   November 2022   March 2023   April 2023   July 2023   September 2023   October 2023   November 2023   April 2024   May 2024   June 2024  

This page is powered by Blogger. Isn't yours?