Big Bang and Economic value added: Difference between pages

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1. ''UK - London Stock Exchange''
(EVA).


'Big Bang' refers collectively to three major changes at the London Stock Exchange which took effect on 27 October 1986:
The periodic addition to shareholder value resulting from the efficient management and allocation of resources.
*The introduction of negotiated brokerage commissions, rather than the fixed commission system previously in force.
*Allowing members both to make markets and to act as brokers ('dual capacity'), rather than being restricted to one role or the other ('single capacity') as in the past.
*Widening of membership and ownership rules, allowing foreign banks to enter the market.


There was also a significant change to introduce electronic trading, replacing the previous 'open outcry' system.


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:


These changes led to a period of rapid expansion, as foreseen and intended by the UK government at the time, led by Prime Minister Margaret Thatcher.
(1) Whenever its returns are inferior to the relevant economic [[cost of capital]].


Some commentators link Big Bang with subsequent excessive risk taking - especially the use of bank depositors' funds for speculative activities - contributing to the conditions which led to the Global Financial Crisis of 2007/08 and onward.
(2) Even if it appears to be profitable when measured on an accounting basis (for example on an [[Earnings per share]] basis).




2.
EVA can be considered at the whole-firm level or in relation to smaller business units or projects.


By extension, the term 'Big Bang' is also used to refer more generally to the changes in - and expansion of - financial markets in the UK (and elsewhere) in the mid-1980s.


__TOC__


3.


By analogy, similar sudden changes in - and subsequent potential expansion of - other markets are also sometimes known as 'Big Bang' events.
== EVA at the whole-firm level ==




The rationale for adopting a 'Big Bang' approach to reforms is that sudden changes may be easier for market participants to engage with and to respond appropriately, rather than incremental changes.
The periodic addition to total shareholder value from the efficient management and allocation of the whole firm's resources.


An alternative view is that such '[[cliff edge]]' events should be avoided, preferring incremental change.


EVA can be quantified at a whole-firm level as:


''The source of the term 'Big Bang' is in cosmology. The widely-accepted Big Bang Theory is that the universe originated from a tiny fireball which exploded with great speed and violence around 14 billion years ago, expanding and cooling to form galaxies, stars and planets.''
EVA = [Return on book capital LESS Market cost of capital] x Book capital.
 
 
<span style="color:#4B0082">'''Example 1: EVA calculation'''</span>
 
Taking a simplified example, take an all-equity financed firm with:
 
(1) A market capitalisation (P<sub>0</sub>) of $130m.
 
(2) Book value of equity $100m.
 
(3) Annual after tax returns of $13m.
 
 
''To keep this illustration simple, we will assume no growth.''
 
''In other words the whole of the annual after tax returns of $13m are paid out as dividends (D<sub>1</sub>).''
 
 
Return on book capital = 13 / 100
= 13%.
 
Market cost of capital = 13 / 130
= 10%
 
(Using Ke = D<sub>1</sub>/P<sub>0</sub>).
 
EVA = [13% - 10% = 3%] x $100m
 
= '''$3m'''.
 
 
''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.''
 
''So the application of EVA analysis is both more complicated, and arguably more subjective, than the simple calculation illustrated above.''
 
 
<span style="color:#4B0082">'''Example 2: MVA calculation'''</span>
 
Turning back for now to our simple example, EVA is also closely related to Market value added (MVA). 
 
MVA is the total present value of the expected EVA in the current and future periods.
 
 
For example in this case the EVA is a simple fixed perpetuity of $3m.
 
The total present value of the fixed perpetuity of $3m is evaluated using:
 
(1) The simple fixed perpetuity formula 1/r.
 
(2) The market cost of capital 10%.
 
 
MVA = $3m / 0.10
 
= '''$30m'''.
 
 
 
== EVA at the individual project level ==
 
 
It is also possible to calculate and analyse EVA at the individual project level.
 
In simple terms, EVA is positive when the project Internal rate of return exceeds the (appropriately risk-adjusted) [[Weighted average cost of capital]].
 
 
A simple decision rule when using EVA at the project level is:
 
(1) Reject all negative EVA projects.
 
(2) Positive EVA projects will be considered further.




== See also ==
== See also ==
*[[Black Friday]]
* [[Net present value]]
*[[Black Monday]]
* [[Internal rate of return]]
*[[Black Wednesday]]
* [[Book value]]
*[[Broker]]
* [[Cost of capital]]
*[[Broker-dealer]]
* [[Earnings per share]]
*[[Cliff edge]]
* [[Excess Return]]
*[[Global Financial Crisis]]
* [[Market value added]]
*[[Institute of Business Ethics]]
* [[Return on capital employed]]
*[[London Stock Exchange]]
* [[Shareholder value]]
*[[Market maker]]
* [[Wealth Added Index]]
*[[Open outcry]]


[[Category:Accounting,_tax_and_regulation]]
[[Category:Corporate_finance]]
[[Category:The_business_context]]
[[Category:Financial_products_and_markets]]

Revision as of 23:30, 15 January 2016

(EVA).

The periodic addition to shareholder value resulting from the efficient management and allocation of resources.


The important insight from EVA analysis is that a whole firm, a project or a division will be destructive of shareholder value in the following circumstances:

(1) Whenever its returns are inferior to the relevant economic cost of capital.

(2) Even if it appears to be profitable when measured on an accounting basis (for example on an Earnings per share basis).


EVA can be considered at the whole-firm level or in relation to smaller business units or projects.



EVA at the whole-firm level

The periodic addition to total shareholder value from the efficient management and allocation of the whole firm's resources.


EVA can be quantified at a whole-firm level as:

EVA = [Return on book capital LESS Market cost of capital] x Book capital.


Example 1: EVA calculation

Taking a simplified example, take an all-equity financed firm with:

(1) A market capitalisation (P0) of $130m.

(2) Book value of equity $100m.

(3) Annual after tax returns of $13m.


To keep this illustration simple, we will assume no growth.

In other words the whole of the annual after tax returns of $13m are paid out as dividends (D1).


Return on book capital = 13 / 100 = 13%.

Market cost of capital = 13 / 130 = 10%

(Using Ke = D1/P0).

EVA = [13% - 10% = 3%] x $100m

= $3m.


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.

So the application of EVA analysis is both more complicated, and arguably more subjective, than the simple calculation illustrated above.


Example 2: MVA calculation

Turning back for now to our simple example, EVA is also closely related to Market value added (MVA).

MVA is the total present value of the expected EVA in the current and future periods.


For example in this case the EVA is a simple fixed perpetuity of $3m.

The total present value of the fixed perpetuity of $3m is evaluated using:

(1) The simple fixed perpetuity formula 1/r.

(2) The market cost of capital 10%.


MVA = $3m / 0.10

= $30m.


EVA at the individual project level

It is also possible to calculate and analyse EVA at the individual project level.

In simple terms, EVA is positive when the project Internal rate of return exceeds the (appropriately risk-adjusted) Weighted average cost of capital.


A simple decision rule when using EVA at the project level is:

(1) Reject all negative EVA projects.

(2) Positive EVA projects will be considered further.


See also

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