Economic value added and Event of default: Difference between pages

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(EVA).
An event of default is the event of breaching a loan agreement or other similar agreement


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


The occurrence of an event of default normally expressly permits the lender to accelerate repayment of the amount outstanding on the loan and to cancel any further lending. However, the lender is not obliged to and may choose not to accelerate repayment.


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:
Each loan agreement will normally define exactly what constitutes an event of default of that agreement.


(1) Whenever its returns are inferior to the relevant economic [[cost of capital]].
 
Events of default will generally include:
*any failure to pay interest or capital on a due date,
*any failure to comply with a covenant or breach other obligations under the agreement, and
*any inability to repeat a representation.


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


 
Cross defaults are defaults in one facility that constitutes a default in another.
EVA can be considered at the whole-firm level or in relation to smaller business units or projects.
 
 
__TOC__
 
 
== 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.
 
 
<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 ==
* [[Net present value]]
* [[Acceleration]]
* [[Internal rate of return]]
* [[Breach of covenant]]
* [[Book value]]
* [[Covenant]]
* [[Cost of capital]]
* [[Cross default]]
* [[Earnings per share]]
* [[Default]]
* [[Excess Return]]
* [[Financial covenant]]
* [[Market value added]]
* [[Forbearance]]
* [[Return on capital employed]]
* [[Grace period]]
* [[Shareholder value]]
* [[Loan agreement]]
* [[Wealth Added Index]]
* [[Material adverse change]]
* [[Putting a limit on losses]]
* [[Representations and warranties]]
* [[Waiver]]


[[Category:Corporate_finance]]
[[Category:Compliance_and_audit]]
[[Category:Identify_and_assess_risks]]

Revision as of 12:30, 30 March 2020

An event of default is the event of breaching a loan agreement or other similar agreement


The occurrence of an event of default normally expressly permits the lender to accelerate repayment of the amount outstanding on the loan and to cancel any further lending. However, the lender is not obliged to and may choose not to accelerate repayment.

Each loan agreement will normally define exactly what constitutes an event of default of that agreement.


Events of default will generally include:

  • any failure to pay interest or capital on a due date,
  • any failure to comply with a covenant or breach other obligations under the agreement, and
  • any inability to repeat a representation.


Cross defaults are defaults in one facility that constitutes a default in another.


See also

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