economic valuation model

7/30/2019 Economic Valuation Model

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Presented By:Tamseel NajmiTabish Jamshed

Syed UmaisSyed OwaisSushangi GoelSyed Yunus FarazShumaila Khan


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A registered trademark redefined and popularised by USbased Stern Stewart & Company.Most accurate value based measure of financialperformance.

Same concept as economic profit. A variation of residual income. A measure indicating amount of shareholder wealthcreated or destroyed during each year. A framework for complete financial management andincentive compensation.


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Stern Stewart & Company defined EVA as an estimateof true economic profit, the amount by which earnings

exceed or fall short of required minimum rate of return investors could get by investing in othersecurities of comparable risk.

It is the net operating profit minus the appropriatecharge for the opportunity cost of capital invested inan enterprise (both debt and equity).

By taking all capital costs into consideration,including cost of equity, EVA shows the amount of wealth a business has created or destroyed in eachreporting period.


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CALCULATE NOPAT

COMPUTE ECONOMICCAPITAL

COMPUTATION OF WACC

CALCULATE COSTOF DEBT

CALCULATE COST OFEQUITY

COMPUTATION OF EVA


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EVA = NOPAT Cost of Capital Employed= NOPAT WACC * CE

where,NOPAT : Net operating profit after taxes butbefore financial costs.

WACC : Weighted average cost of capital

CE : Capital employed


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If rate of return is defined as NOPAT/Capital Employed,

EVA = (Rate of Return Cost of Capital) * CapitalEmployed

where,

Rate of Return : NOPAT/Capital Employed

Capital Employed : Total of Balance sheet Non-Interestbearing current liabilities (NIBCL) in the beginning of the year.

Cost of Capital : Cost of equity*proportion of equity in capital+ cost of debt * proportion of debt in capital(1 - tax)


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Also, EVA can be written as :EVA = (ROI WACC) * Capital Employed

where,

Capital Employed : Net fixed assets RevenueReserves Capital work in

progress + Current assets Funds deployed outsidebusiness NIBCL


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EVA is closely related to NET PRESENT VALUE (NPV).It argues that value of firm will increase if you opt forpositive NPV projects.

It has high correlation with the market value of thefirm .Its application to employees compensation leads to thealignment of managerial interests with those of the

shareholdersIt is near to the real cash flows of the business entity .


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VALUATIONLeading investment firms such as Goldman Sachs , MerrylLynch , Morgan Stanley , Robert Flemming etc are usingEVA as a primary valuation tool.

ACQUISITIONSIn one of the largest acquisition in recent years , AT & Tused EVA method to decide on $126 billion purchase of

McCaw cellular .The ball corporation rejected acquisition of Eastman Kotakunit because it failed the EVA test for creating valueHeekin can inc passed the EVA test and so , was acquired .


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STRATEGIC DECISION MAKING

IBM applied EVA to Evaluate strategic plans for the key Latin American markets such as Mexico brazil and Argentina . At Georgia pacific strategic focus shiftedfrom profit creation to value creation .

OPERATIONAL IMPROVEMENT

Briggs and Stratton realized that its return on capital was poor and getting lower. They restructured theiroperations and adopted EVA as a way of focusingmanagers attention on how they were employing

capital .


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PRODUCT LINE DICONTINUATION

EVA helped coca cola to identify and sell those business thatfailed to recover cost of capital . Perfect data corporation andincstar both discontinued un profitable product lines based onEVA analysis .

INCENTIVE COMPENSATION

Compensation of supervisor and managers above certain salary in coke is linked to EVA . In trans America 100% of annualbonuses of ceos and cfos is based on EVA .

In India at niit Infosys technologies and gogrej soaps , EVA linked compensation plan has been adopted .


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COST OF CAPITAL FOCUS

Dow chemicals use EVA to shed light on cost to runbusiness and return a positive economic profit .DEEREand company used EVA to focus management on the value drivers of its business and the true cost of its

asset based . AT& T changed it focus from income statementearnings to a broader view that included balance sheet.


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WORKING CAPITAL FOCUS

Quaker oats used EVA to account for large dollaramount tied up in finished goods and packagingmaterial inventory .Morrison restaurants used EVA to focus on

management and its receivables .


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A performance measure that can be maximized as anobjective .It can be used as a metric to evaluate capital budgetingproposals ( it is the only measure of both ,performance evaluation and strategic decision making ).It integrates effect of profitability and growth into the

same measure.


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It simplifies the concept of profitability which wasearlier complex with the complex measures.

It has good correlation with market capitalization .

It unifies the goal of companies and their shareholders.


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economic valuation model

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