imported>Doug Williamson |
imported>Doug Williamson |
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| (EVA).
| | Economics is the social science that seeks to understand the interaction between people and the production, distribution, and consumption of goods and services. |
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| The periodic addition to shareholder value resulting from the efficient management and allocation of resources. | | The study of economics provides a platform for understanding business and a reference framework for business systems and techniques. |
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| The important insight from EVA analysis is that a whole firm, a project or a division will be <u>destructive</u> of [[shareholder value]] in the following circumstances:
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| (1) Whenever its returns are inferior to the relevant economic [[cost of capital]].
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| (2) Even if it appears to be profitable when measured on an accounting basis (for example on an [[Earnings per share]] basis).
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| EVA can be considered at the whole-firm level or in relation to smaller business units or projects.
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| __TOC__
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| == EVA at the whole-firm level ==
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| The periodic addition to total shareholder value from the efficient management and allocation of the whole firm's resources.
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| EVA can be quantified at a whole-firm level as:
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| EVA = [Return on book capital LESS Market cost of capital] x Book capital.
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| <span style="color:#4B0082">'''Example 1: EVA calculation'''</span>
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| Taking a simplified example, take an all-equity financed firm with:
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| (1) A market capitalisation (P<sub>0</sub>) of $130m.
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| (2) Book value of equity $100m.
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| (3) Annual after tax returns of $13m.
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| ''To keep this illustration simple, we will assume no growth.''
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| ''In other words the whole of the annual after tax returns of $13m are paid out as dividends (D<sub>1</sub>).''
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| Return on book capital = 13 / 100
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| = 13%.
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| Market cost of capital = 13 / 130
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| = 10%
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| (Using Ke = D<sub>1</sub>/P<sub>0</sub>).
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| EVA = [13% - 10% = 3%] x $100m
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| = '''$3m'''.
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| ''In practice a number of adjustments would be made both to the market values and to the book values used in the calculation of the EVA.''
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| ''So the application of EVA analysis is both more complicated, and arguably more subjective, than the simple calculation illustrated above.''
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| <span style="color:#4B0082">'''Example 2: MVA calculation'''</span>
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| Turning back for now to our simple example, EVA is also closely related to Market value added (MVA).
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| MVA is the total present value of the expected EVA in the current and future periods.
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| For example in this case the EVA is a simple fixed perpetuity of $3m.
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| The total present value of the fixed perpetuity of $3m is evaluated using:
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| (1) The simple fixed perpetuity formula 1/r.
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| (2) The market cost of capital 10%.
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| MVA = $3m / 0.10
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| = '''$30m'''.
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| == EVA at the individual project level ==
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| It is also possible to calculate and analyse EVA at the individual project level.
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| In simple terms, EVA is positive when the project Internal rate of return exceeds the (appropriately risk-adjusted) [[Weighted average cost of capital]].
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| A simple decision rule when using EVA at the project level is:
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| (1) Reject all negative EVA projects.
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| (2) Positive EVA projects will be considered further.
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| == See also == | | == See also == |
| * [[Book value]] | | * [[Econometrics]] |
| * [[Cost of capital]]
| | * [[Economic environment]] |
| * [[Earnings per share]]
| | * [[Economy]] |
| * [[Economic value]] | | * [[Finance]] |
| * [[Excess Return]]
| | * [[Macroeconomics]] |
| * [[Gearing]]
| | * [[Microeconomics]] |
| * [[Internal rate of return]]
| | * [[Wants]] |
| * [[Market value added]]
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| * [[Net present value]] | |
| * [[Return on capital]] | |
| * [[Return on capital employed]] | |
| * [[Shareholder value]] | |
| * [[Wealth Added Index]] | |
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| [[Category:Corporate_finance]] | | [[Category:The_business_context]] |
| | [[Category:Financial_products_and_markets]] |
