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### Transcript of Economic Value Added

Corporate finance

Working capital

Cash conversion cycle Return on capital

Just-in-time

Economic order quantity Discounts and allowances

Factoring

Capital budgeting

Capital investment decisions The investment decision The financing decision Sections

Managerial finance Financial accounting Management accounting Mergers and acquisitions Balance sheet analysis

Business plan Corporate action

Societal components

Financial market

Financial market participants Corporate finance Personal finance

Public finance Banks and banking Financial regulation

Clawback

V

T

E

In corporate finance, Economic Value Added or EVA, is an estimate of a firm's economic profit being the value created in excess of the required return of thecompany's investors (being shareholders and debt holders). Quite simply, EVA is the profit earned by the firm less the cost of financing the firm's capital. The idea is that value is created when the return on the firm's economic capital employed is greater than the cost of that capital; see Corporate finance: working capital management. This amount can be determined by making adjustments to GAAP accounting. There are potentially over 160 adjustments that could be made but in practice only five or seven key ones are made, depending on the company and the industry it competes in.Contents[hide]

1 Calculating EVA 2 Comparison with other approaches 3 Relationship to market value added 4 Integrating EVA and PBC 5 See also 6 References 7 External links

Calculating

EVA

EVA is net operating profit after taxes (or NOPAT) less a capital charge, the latter being the product of the cost of capital and the economic capital. The basic formula is:

where:

, is the Return on Invested Capital (ROIC); is the weighted average cost of capital (WACC);

is the economic capital employed; NOPAT is the net operating profit after tax, with adjustments and translations, generally for the amortization of goodwill, the capitalization of brand advertising and others non-cash items.

EVA Calculation: EVA = net operating profit after taxes a capital charge [the residual income method] therefore EVA = NOPAT (c capital), or alternatively EVA = (r x capital) (c capital) so that EVA = (r-c) capital [the spread method, or excess return method] where:

r = rate of return, and c = cost of capital, or the Weighted Average Cost of Capital (WACC).

NOPAT is profits derived from a companys operations after cash taxes but before financing costs and non-cash bookkeeping entries. It is the total pool of profits available to provide a cash return to those who provide capital to the firm. Capital is the amount of cash invested in the 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 (NIBCLs). The capital charge is the cash flow required to compensate investors for the riskiness of the business given the amount of economic capital invested. The cost of capital is the minimum rate of return on capital required to compensate investors (debt and equity) for bearing risk, their opportunity cost. Another perspective on EVA can be gained by looking at a firms return on net assets (RONA). RONA is a ratio that is calculated by dividing a firms NOPAT by the amount of capital it employs (RONA = NOPAT/Capital) after making the necessary adjustments of the data reported by a conventional financial accounting system. EVA = (RONA required minimum return) net investments If RONA is above the threshold rate, EVA is positive.

Comparison

with other approaches

Other approaches along similar lines include Residual Income Valuation (RI) and residual cash flow. Although EVA is similar to residual income, under some definitions there may be minor technical differences between EVA and RI (for example, adjustments that might be made to NOPAT before it is

suitable for the formula below). Residual cash flow is another, much older term for economic profit. In all three cases, money cost of capital refers to the amount of money rather than the proportional cost (% cost of capital); at the same time, the adjustments to NOPAT are unique to EVA. Although in concept, these approaches are in a sense nothing more than the traditional, commonsense idea of "profit", the utility of having a separate and more precisely defined term such as EVA is that it makes a clear separation from dubious accounting adjustments that have enabled businesses such as Enron to report profits while actually approaching insolvency. Other measures of shareholder value include:

Added value Market value added Total shareholder return.

Relationship

to market value added

The firm's market value added, or MVA, is the discounted sum (present value) of all future expected economic value added:

Note that MVA = PV of EVA. More enlightening is that since MVA = NPV of Free cash flow (FCF) it follows therefore that the NPV of FCF = PV of EVA; since after all, EVA is simply the re-arrangement of the FCF formula.

Integrating

EVA and PBC

Recently, Mocciaro Li Destri, Picone & Min (2012)[1] proposed a performance and cost measurement system that integrates the EVA criteria with Process Based Costing (PBC). The EVA-PBC methodology allows us to implement the EVA management logic non only at the firm level, but also at lower levels of the organization. EVA-PBC methodology plays an interesting role in bringing strategy back into financial performance measures.

Business valuation is a process and a set of procedures used to estimate the economic value of an owners interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to perfect a sale of a business. In addition to estimating the selling price of a

business, the same valuation tools are often used by business appraisers to resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among business assets, establish a formula for estimating the value of partners' ownership interest for buy-sell agreements, and many other business and legal purposes.Contents[hide]

1 Standard and premise of value 2 There are two premises of Value 3 Elements of business valuation

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3.1 Economic conditions 3.2 Financial analysis 3.3 Normalization of financial statements 3.4 Income, asset and market approaches

4 Income approaches

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4.1 Discount or capitalization rates

4.1.1 Capital Asset Pricing Model (CAPM) 4.1.2 Modified Capital Asset Pricing Model 4.1.3 Weighted average cost of capital ("WACC") 4.1.4 Build-Up Method

5 Asset-based approaches 6 Market approaches

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6.1 Guideline Public Company method 6.2 Guideline Transaction Method or Direct Market Data Method

7 Option pricing approaches 8 Discounts and premiums

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8.1 Discount for lack of control 8.2 Discount for lack of marketability

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8.2.1 Restricted stock studies 8.2.2 Option pricing 8.2.3 Pre-IPO studies

8.3 Applying the studies