Economic value added and Equity: Difference between pages

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(EVA).  
1. ''Financial reporting - balance sheet''.


The periodic addition to shareholder value resulting from the efficient management and allocation of resources.
Amounts in the balance sheet of a company representing the book value of the interests of the shareholders.


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:
It includes share capital, cumulative retained profits (or losses), and other reserves.


(1) Whenever its returns are inferior to the relevant economic [[cost of capital]].
It is also known as 'total equity' or 'shareholders' funds'.


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


The book value of total equity is equal to the book value of the company's net assets (or net liabilities).


EVA can be considered at the whole-firm level or in relation to smaller business units or projects.
These two items in a balance sheet always balance - so long as there are no errors.


This is what is meant by a balance sheet "balancing".




== EVA at the whole-firm level ==
2. ''Financial reporting''.


Comparable amounts for financial reporting entities that are not companies.


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


3. ''Capital investment.''


EVA can be quantified at a whole-firm level as:
The capital of a firm invested by those accepting the greatest degree of risk, for example the holders of ordinary shares (also known as common stock or common equity) in a company.


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


4. ''Securities.''


<span style="color:#4B0082">'''Example 1: EVA calculation'''</span>
Securities representing the rights of the risk capital investors in 3. above.


Taking a simplified example, take an all-equity financed firm with:
For example, ordinary shares, also known as common stock.


(1) A market capitalisation (P<sub>0</sub>) of $130m.


(2) Book value of equity $100m.
5. ''Banking and bank regulation''.


(3) Annual after tax returns of $13m.
Abbreviation for common equity.




''To keep this illustration simple, we will assume no growth.''  
6. ''Net asset value.''


''In other words the whole of the annual after tax returns of $13m are paid out as dividends (D<sub>1</sub>).''
The net value of an asset, after deducting any debt relating to it or secured on it.


For example, the value of a residential property, after deducting the amount of a mortgage borrowing secured on it.


Return on book capital = 13/100
If the value of the borrowing exceeds the value of the asset, the situation can be described as 'negative equity'.  
= 13%.


Market cost of capital = 13/130
= 10%


(Using Ke = D<sub>1</sub>/P<sub>0</sub>).
:<span style="color:#4B0082">'''''Example: Equity and Negative equity'''''</span>


EVA = [13% - 10% = 3%] x $100m
:A house is worth EUR 400k.


= '''$3m'''.
:A borrowing of EUR 300k is secured by a mortgage over the house.


:The net worth is the difference between the value of the the house (asset) EUR 400k and the borrowing (liability) EUR 300k


''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.''
:400k - 300k = EUR 100k


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


:The Equity in the house is the difference between the current value, and any loans secured over it.
:This is also EUR 100k.


<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).
:If the value of the house falls to EUR 250k, the borrowing now exceeds the value of the asset.


MVA is the total present value of the expected EVA in the current and future periods.
:This is 'negative equity' (of EUR 50k = 250k - 300k).




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


The total present value of the fixed perpetuity of $3m is evaluated using:
A legal system that resolves disputes between persons by resort to principles of fairness and justness.


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


(2) The market cost of capital 10%.
8. ''Ethics - governance''.


Fair treatment between different individuals and different groups.


MVA = $3m/0.10


= '''$30m'''.
:<span style="color:#4B0082">'''''Equity & inclusion are priority for investors'''''</span>


:“Diversity, equity and inclusion is emerging as a priority topic for investors, with some of the world’s largest asset managers reporting increased engagement with portfolio companies in this area."


:''FitchRatings - November 2021.''


== 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]]
* [[An introduction to equity capital]]
* [[Internal rate of return]]
* [[Asset manager]]
* [[Assets]]
* [[Balance]]
* [[Balance sheet]]
* [[Blue chip]]
* [[Book value]]
* [[Book value]]
* [[Cost of capital]]
* [[Capital]]
* [[Earnings per share]]
* [[Capital employed]]
* [[Excess Return]]
* [[Capital structure]]
* [[Market value added]]
* [[Common equity]]
* [[Return on capital employed]]
* [[Common law]]
* [[Common stock]]
* [[Compound instrument]]
* [[Cost of equity]]
* [[Debt]]
* [[Debt for equity swap]]
* [[Debt to equity ratio]]
* [[Diversity]]
* [[Dividend]]
* [[Dividend growth model]]
* [[Entity]]
* [[Equality]]
*[[Equitable]]
* [[Equity accounting]]
* [[Equity beta]]
* [[Equity capital]]
* [[Equity cost of capital]]
* [[Equity instrument]]
* [[Equity investments]]
* [[Equity market]]
* [[Equity method]]
* [[Equity risk]]
* [[Equity risk premium]]  (ERP)
* [[Equity structured deposit]]
* [[Equity swap]]
* [[Fitch]]
* [[Green equity]]
* [[Hybrid capital]]
* [[Inclusion]]
* [[Kay Review]]
* [[Liabilities]]
* [[Liabilities and equity]]
* [[Market/book ratio]]
* [[Member]]
* [[Mezzanine]]
* [[Mortgage]]
* [[Negative equity]]
* [[Net assets]]
* [[Net worth]]
* [[Ordinary shares]]
* [[Own funds]]
* [[Private equity]]
* [[Quasi-equity]]
* [[Reporting entity]]
* [[Reserves]]
* [[Return on equity]]
* [[Risk]]
* [[Share]]
* [[Share capital]]
* [[Shareholder]]
* [[Shareholder value]]
* [[Shareholder value]]
* [[Wealth Added Index]]
* [[Shareholders’ funds]]
* [[Shareholders’ wealth]]
* [[Stakeholder]]
* [[Statement of changes in equity]]
* [[Statement of shareholders' equity]]
* [[Stock]]
* [[Total Loss Absorbing Capacity]]
* [[Total return swap]]


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

Revision as of 15:05, 16 September 2022

1. Financial reporting - balance sheet.

Amounts in the balance sheet of a company representing the book value of the interests of the shareholders.

It includes share capital, cumulative retained profits (or losses), and other reserves.

It is also known as 'total equity' or 'shareholders' funds'.


The book value of total equity is equal to the book value of the company's net assets (or net liabilities).

These two items in a balance sheet always balance - so long as there are no errors.

This is what is meant by a balance sheet "balancing".


2. Financial reporting.

Comparable amounts for financial reporting entities that are not companies.


3. Capital investment.

The capital of a firm invested by those accepting the greatest degree of risk, for example the holders of ordinary shares (also known as common stock or common equity) in a company.


4. Securities.

Securities representing the rights of the risk capital investors in 3. above.

For example, ordinary shares, also known as common stock.


5. Banking and bank regulation.

Abbreviation for common equity.


6. Net asset value.

The net value of an asset, after deducting any debt relating to it or secured on it.

For example, the value of a residential property, after deducting the amount of a mortgage borrowing secured on it.

If the value of the borrowing exceeds the value of the asset, the situation can be described as 'negative equity'.


Example: Equity and Negative equity
A house is worth EUR 400k.
A borrowing of EUR 300k is secured by a mortgage over the house.
The net worth is the difference between the value of the the house (asset) EUR 400k and the borrowing (liability) EUR 300k
400k - 300k = EUR 100k


The Equity in the house is the difference between the current value, and any loans secured over it.
This is also EUR 100k.


If the value of the house falls to EUR 250k, the borrowing now exceeds the value of the asset.
This is 'negative equity' (of EUR 50k = 250k - 300k).


7. Law.

A legal system that resolves disputes between persons by resort to principles of fairness and justness.


8. Ethics - governance.

Fair treatment between different individuals and different groups.


Equity & inclusion are priority for investors
“Diversity, equity and inclusion is emerging as a priority topic for investors, with some of the world’s largest asset managers reporting increased engagement with portfolio companies in this area."
FitchRatings - November 2021.


See also

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