imported>Doug Williamson |
imported>Doug Williamson |
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| (EVA).
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| The important insight from EVA analysis is that a whole firm, a project or a division is <u>destructive</u> of [[shareholder value]]:
| | A basis of allocating costs or allowances across successive time periods by applying a consistent periodic percentage charge to - for example - the reducing net book value of a fixed asset. |
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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).
| | For example, |
| | a fixed asset has a cost of $12m, to be depreciated on a reducing balance basis at a rate of 40% per year. |
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| | The depreciation charge for Year 1 would be |
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| EVA can be considered at the whole-firm level or in relation to smaller business units or projects.
| | $12m x 40% |
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| | = $4.8m. |
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| == EVA at the whole-firm level ==
| | The net book value at the end of Year 1 (and the start of Year 2) |
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| | = 12 - 4.8 |
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| The periodic addition to shareholder value resulting from the efficient management and allocation of a whole firm's resources.
| | = $9.2m. |
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| EVA can be quantified at a whole-firm level as:
| | The depreciation charge for Year 2 |
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| EVA = [Return on book capital LESS Market cost of capital] x Book capital.
| | = $9.2m x 40% |
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| | = $3.68m. |
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| '''''Example'''''
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| Taking a simplified example, take an all-equity financed firm with:
| | The net book value at the end of Year 2 (and the start of Year 3) |
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| (1) A market capitalisation (P<sub>0</sub>) of $130m.
| | = 9.2 - 3.68 |
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| (2) Book value of equity $100m.
| | = $5.52m. |
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| (3) Annual after tax returns of $13m.
| | And so on. |
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| | Using a reducing balance basis of depreciation, the net book value never falls to zero (unless the asset is disposed of). |
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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>).''
| | 2. |
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| | ''UK tax.'' |
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| Return on book capital = 13/100
| | UK Writing Down tax Allowances are normally available to be claimed on a reducing balance basis. |
| = 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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| '''''Example'''''
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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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| | == See also == |
| | * [[Depreciation]] |
| | * [[Straight line]] |
| | * [[Sum of the digits]] |
| | * [[Writing down allowance]] |
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| It is also possible to calculate and analyse EVA at the individual project level.
| | [[Category:Accounting,_tax_and_regulation]] |
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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 ==
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| * [[Net present value]]
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| * [[Internal rate of return]]
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| * [[Book value]]
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| * [[Cost of capital]]
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| * [[Earnings per share]]
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| * [[Excess Return]]
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| * [[Market value added]]
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| * [[Return on capital employed]]
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| * [[Shareholder value]]
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| * [[Wealth Added Index]]
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1.
A basis of allocating costs or allowances across successive time periods by applying a consistent periodic percentage charge to - for example - the reducing net book value of a fixed asset.
For example,
a fixed asset has a cost of $12m, to be depreciated on a reducing balance basis at a rate of 40% per year.
The depreciation charge for Year 1 would be
$12m x 40%
= $4.8m.
The net book value at the end of Year 1 (and the start of Year 2)
= 12 - 4.8
= $9.2m.
The depreciation charge for Year 2
= $9.2m x 40%
= $3.68m.
The net book value at the end of Year 2 (and the start of Year 3)
= 9.2 - 3.68
= $5.52m.
And so on.
Using a reducing balance basis of depreciation, the net book value never falls to zero (unless the asset is disposed of).
2.
UK tax.
UK Writing Down tax Allowances are normally available to be claimed on a reducing balance basis.
See also
