51396384 Economic Value Added EVA of Sample Companies

Computation of Economic Value Added (EVA) of Sample Companies

M P Birla Institute of Management, Bangalore 1

Computation of Economic Value Added (EVA) of Sample

Companies

A dissertation submitted in partial fulfillment of the requirements for the award of MBA degree of Bangalore University.

Submitted By

Ashwani Kumar Kedia

(REGD. NO: 05XQCM6013)

Under The Guidance and Supervision OF

Dr. N. S. Malavalli, Principle M.P. Birla Institute of Management.

M. P. BIRLA INSTITUTE OF MANAGEMENT Associate Bharatiya Vidya Bhavan

# 43 Race Course Road, Bangalore-560001 2006-07



DECLARATION

I, Ashwani Kumar Kedia, do hereby declare that this project report entitled

“Computation of Economic Value Added (EVA) of Sample Companies” is an

original research work carried out by me, towards the partial fulfillment of requirements

for the M.B.A. degree course of Bangalore University at M.P. Birla Institute of

Management. I also declare that this dissertation has not been submitted to any

University/Institution for the award of any Degree/Diploma.

Place: Bangalore

Date: 15th May 2007 (Ashwani Kumar Kedia)



PRINCIPAL’S CERTIFICATE

This is to certify that this report is the result of Project “Computation of Economic

Value Added (EVA) of Sample Companies” undergone by Mr. Ashwani Kumar Kedia

bearing the register number 05XQCM6013 under the guidance and supervision of Dr. N.

S. Malavalli, M.P. Birla Institute of Management. This has not formed a basis for the

award of any Degree/ Diploma of any University.

Date: Dr Nagesh. Malavalli

Place: Bangalore (Principal)



GUIDE’S CERTIFICATE

This is to certify that this report is the result of Project “Computation of Economic

Value Added (EVA) of Sample Companies” undergone by Mr. Ashwani Kumar Kedia,

bearing the register number 05XQCM6013 is a bonafied work done carried under my

guidance and supervision during the academic year 2005-2007 in the partial fulfillment of

the requirement for the award of MBA degree by Bangalore University. To the best of

my knowledge this report has not formed the basis for the award of any other degree.

Date: Dr. N. S. Malavalli

Place: Bangalore (Principal)



ACKNOWLEDGEMENT

The research work which I had done gave me enormous amount of knowledge and the

understanding of various financial issues related to the firm’s Computation of EVA. This

research project work is made successful by the combining efforts of a no. of officials

and bears the imprint of many people. This project can not be said completed unless and

until, I fulfill my duty of thanking those persons to whom I deeply indebted. I wish to

express my deep gratitude towards them to their whole hearted support and existence.

Firstly I would like to thank Dr. N. S. Malavalli, principal, M P Birla Institute of

Management, Bangalore, who has given his valuable support and guidance in carrying

out this project work.

I am also extremely thankful to Dr. T. V. N. Rao, Professor, M P Birla Institute of

Management, Bangalore, who has guided me to do this project by giving valuable

suggestion and advice.

Further, I am grateful to Professor Santhanam, Professor, M P Birla Institute of

Management, Bangalore, who gave his suggestions to improve the accuracy and the

dependability of the data.

They all guided me during the period and helped me in each and every step to prepare

this report.

DATE: Ashwani Kumar Kedia



-CONTENTS- Particulars Page No. 1) Chapter – 1

Abstract 08

Introduction 09

Problem Statement 11

Research Objective 11

Background of EVA 12

2) Chapter – 2 REVIEW OF LITERATURE 16

3. Chapter – 3 METHODOLOGY 19

4. Chapter – 4 DATA ANALYSIS 23

5. Chapter – 5 DISCUSSION & CONCLUSION 34

6. Chapter – 6 BIBLIOGRAPHY & REFERENCES 37

7. Chapter – 7 ANNEXURE 46

TABLES Beta of Sample companies 24

NOPAT Sample companies 25

Capital Employed of Sample Companies 26

WACC of Sample Companies 27 EVA of Sample Companies 29

EVA and Adjusted Market price 31



Chapter-1



ABSTRACT

The value-based management performance measure EVA introduced by Stern Stewart &

Co. is an incarnation of the underlying residual income (RI) concept. The concept is

evaluated and compared with traditional profitability measures within a controlled

simulation framework. It is observed that EVA is very sensitive to its cost of equity

component, but it is unexpectedly insensitive to its cost of debt component under regular

conditions. EVA and its variability are observed to be strongly affected by the firm's

growth policies because of leverage effects. EVA is observed to be much more unstable

than the traditional return on investment and directly related to the return on equity

measure. Methodologically, the paper demonstrates the advantages of using a controlled

simulation approach in financial research.

The EVA is computed of 20 companies of the NIFTY for a period of 5 years beginning

from FY 2001-02 to FY 2005-06. EVA is equal to NOPAT (Net Operating Profit) minus

WACC (Weighted Average Cost of Capital). NOPAT is EBIT after taxes. Cost of equity

is calculated using CAPM Model. Beta is calculated based on monthly high low average

of past three years.

From the study it is observed that there is no strong pattern of wealth created by

companies. EVA of different companies varies year to year based on its overall cost of

capital and cost of equity is more influential factor. It is also found that EVA and market

price has no good relation for the sample companies. And thus we can say that investors

do not consider EVA for the investment decision.



INTRODUCTION

With increasing pressure on firms to deliver shareholder value, there has been a renewed

emphasis on devising measures of corporate financial performance and incentive

compensation plans that encourage managers to increase shareholder wealth. One

professedly recent innovation in the field of internal and external performance

measurement is a trade-marked variant of residual income known as economic value-

added (EVA). Economic Value Added (EVA) is a value-based framework that provides a unique insight

into value creation and unites the finance theory with the competitive strategy

framework. Economic Value Added (EVA) is a relatively new concept in the area of

financial management. It is the financial performance measure that comes closest than

any other to capture the true economic profit of a firm. EVA is the performance measure

most directly linked to the creation of shareholder wealth over time. It is a value-based

framework that provides a unique insight into value creation and unites the finance theory

with the competitive strategy framework. The financial concept underlying EVA was

originally propagated by Adam Smith, who proclaimed that the social mission of an

individual enterprise is to maximize the value of shareholders. Further contributions were

made by Merton Miller and Stern Stewart.

Stern Stewart developed EVA to help managers incorporate two basic principles of

finance into their decision making: One, the primary objective of maximizing the wealth

of its shareholders; and two, accepting that the value of a company depends on the extent

to which investors expect future profits to exceed or fall short of the cost of capital.

EVA is the net operating profit minus an appropriate charge for the opportunity cost of

all capital invested in an enterprise. Hence, EVA is an estimate of true economic profit,

or the amount by which earnings exceed or fall short of the required minimum rate of

return those shareholders and lenders could get by investing in other securities of

comparable risk. Jenson (1986) argues that managers do not like to disburse free cash to

investors even when no positive present value project is available.

Capital charge is the most important characteristic of EVA. Under conventional

accounting, most companies seem profitable while, in fact, they may not be. By taking all



capital costs into account, including the cost of equity, EVA shows the amount of wealth

in rupee a business has created or destroyed in each reporting period. In other words,

EVA is the profit as defined by the shareholders.

A sustained increase in EVA will bring an increase in the market value of a company.

EVA has the advantage of being conceptually simple and easy to explain, since it starts

with familiar operating profits and deducts a charge for the capital invested in the

company. By assessing a charge for using capital, EVA makes managers care about

managing assets as well as income and helps them properly assess the trade-offs between

the two.

Above all, EVA helps in overcoming the ambiguity of financial goals. Most companies

use a plethora of measures to express their financial goals and objectives. Strategic plans

often are based on growth in revenue or market share. Companies usually evaluate

individual products or lines of business on the basis of gross margins. Business units may

be evaluated in terms of return on assets.

Finance departments usually analyze capital investments in terms of the net present

value, but weigh prospective acquisitions against the likely contribution to the earnings

growth. The result of the inconsistent standards, goals and terminology usually results in

cohesive planning, operating strategy and decision making. EVA eliminates this

perplexity by using a single financial measure that links decision making with a common

focus.



PROBLEM STATEMENT

Investors who have a variety of options will evaluate the performance of various

companies based on the returns they provide, before making investments. In this context,

it is relevant to see whether companies are earning returns on their costs, and thereby,

creating wealth for their shareholders.

NEED AND IMPORTANCE OF THE STUDY: Investors who have a variety of options will evaluate the performance of companies

based on the returns they provide, before making investments. Companied need to

improve their financial performance to meet the expectations of investors. So, creation of

wealth is an important task for companies. Non-creation of EVA leads to investor

dissatisfaction. This will affect the equity mobilization activities of companies, which

have a great impact on the economy.

In this context, it is relevant to see whether companies are earning returns on their costs,

and thereby, creating wealth for their shareholders.

THE OBJECTIVE THE STUDY:

To measure the economic value added of selected companies



THE BACKGROUND OF EVA

EVA is not a new discovery. An accounting performance measure called residual income

is defined to be operating profit subtracted with capital charge. EVA is thus one variation

of residual income with adjustments to how one calculates income and capital. According

to Wallace (1997, p.1) one of the earliest to mention the residual income concept was

Alfred Marshall in 1890. Marshall defined economic profit as total net gains less the

interest on invested capital at the current rate. According to Dodd & Chen (1996, p.27)

the idea of residual income appeared first in accounting theory literature early in this

century by e.g. Church in 1917 and by Scovell in 1924 and appeared in management

accounting literature in the 1960s. Also Finnish academics and financial press discussed

the concept as early as in the 1970s. It was defined as a good way to complement ROI-

control (Virtanen 1975, p.111). Knowing this background many academics have been

wondering about the big publicity and praise that has surrounded EVA in the recent

years. The EVA-concept is often called Economic Profit (EP) in order to avoid problems

caused by the trademarking. On the other hand the name "EVA" is so popular and well

known that often all residual income concepts are often called EVA although they do not

include even the main elements defined by Stern Stewart & Co. For example, hardly any

of those Finnish companies that have adopted EVA calculate rate of return based on the

beginning capital as Stewart has defined it, because average capital is in practice a better

estimate of the capital employed. So they do not actually use EVA but other residual

income measure. This insignificance detail is ignored later on in order to avoid more

serious misconceptions. It is justified to say that the EVA concept Finnish companies are

using corresponds virtually the EVA defined by Stern Stewart & Co.

In the 1970s or earlier residual income did not got wide publicity and it did not end up to

be the prime performance measure in great deal of companies. However EVA, practically

the same concept with a different name, has done it in the recent years. Furthermore the

spreading of EVA and other residual income measures does not look to be on a

weakening trend. On the contrary the number of companies adopting EVA is increasing

rapidly. We can only guess why residual income did never gain a popularity of this scale.

One of the possible reasons is that Economic value added (EVA) was marketed with a



concept of Market value added (MVA) and it did offer a theoretically sound link to

market valuations. In the times when investors demand focus on Shareholder value issues

this was a good bite EVA measures whether the operating profit is enough compared to

the total costs of capital employed. Stewart defined EVA (1990, p.137) as Net operating

profit after taxes (NOPAT) subtracted with a capital charge.

At operational level this new approach leads often to increased shareholder value through

increased capital turnover (Wallace 1997, p.16). In many companies everything has been

done in cutting costs but the capital efficiency has been ignored. EVA has been helpful

because it forces to pay attention to capital employed and especially to excess working

capital. Allocating the capital costs to their originators i.e. individual functions of

organization can further reinforce this impact.

One of EVA's most powerful features is its suitability to management bonus systems.

This have been empirically proofed to be good way to increase shareholder value

(Wallace 1997). The good feasibility for this purpose is due to the nature of EVA as

excess return to shareholders. When EVA is maximized also shareholder value is

maximized. The idea of EVA bonuses is that if management can be paid some bonuses,

the shareholders have always earned higher return on their capital than they can expect.

This kind of bonus system is usually beneficial both to management and the shareholders,

because the performance level is likely to rise after introducing EVA bonus system. EVA

bonus paid is far from a cost to shareholders, because it is often a share in the

discretionary value created. With well designed bonus plan, the higher the bonuses that

are paid, the better it is for the shareholders. In order to be successful, EVA based bonus

systems should be long-term, based mainly on changes of EVA and offer considerable

bonuses for considerable shareholder value improvements.



With implementation it is important to understand the EVA-concept thoroughly and tailor

the concept to the unique situation of each company or business unit. EVA is at its best as

an overall measure and organizational approach with strong link to payroll of managers

and other employees. That kind utilization can not succeed without deep understanding

and commitment achieved with proper training.

EVA = NOPAT – CAPITAL COST

EVA = NOPAT – COST OF CAPITAL x CAPITAL EMPLOYED

Terminology

Shareholder value = Shareholder value is being used as a overall term covering various

aspects in thinking that promotes the interests of shareholders. Normally the term also

means a company’s value to its shareholders i.e. market capitalization.

Shareholder value approach = Shareholder value approach refers to the focus of

organization and management on acting within the interests of shareholders. Hence it

means focus on maximizing the wealth of shareholders (creating shareholder value).

Value based measures = Value based measures are new performance measures that

originate from the shareholder value approach. They seek to measure the periodic

performance in terms of shareholder value created (or destroyed).

Cost of Equity: Cost of equity is the minimum rate of return, which has to be made from

an equity-financed project, in order to maintain the present wealth of the shareholders

unaffected. It can be computed based on Capital Asset Pricing Model (CAPM).

According to CAPM,

Cost of Equity Ke = Risk-free Rate + (Beta x Market Premium).



Risk-free Rate: Risk-free rate is the rate of return from securities, which are free from

any type of risk. Generally, government-backed securities are considered as risk-free

securities. So, the yield on the 364-day Government of India Treasury Bill is considered

as risk-free rate [Thampy et al. (2001), Sen et al. (2003)]. Theses show 9.7583%,

7.1016% and 5.9251% for years 2000-01, 2001-02 and 2002-03 respectively.

Beta: Beta is the measure of the volatility of a stock in relation to the market. It is the

index of systematic risk. Beta for the each stock was calculated based on the daily stock

price with the Bombay Stock Exchange’s sensex returns as the proxy for the market

returns. Beta was calculated by using the data from the period April 1, 2002 to March 31,

2003.

Market Premium: Market premium is the excess return offered by the market over the

risk-free rate. It is considered as 7%, since some of the leading firms like Infosys used the

same rate while calculating EVA for their firm.



Chapter-2



LITERATURE REVIEW:

Stern Stewart (1990, p.215 - 218) has first studied this relationship with market data of

618 U.S. companies. Stewart presents the results in his book "The quest for value".

Stewart has studied the relationship between EVA and market value of the company and

he has produced a list of companies’ EVA annually since 1982, its coverage is limited to

the largest 1,000 companies. He states that EVA and MVA correspond each other in

reality quite well among US companies (the data was from late 1980’s). Only the

relationship between negative EVA and negative MVA does not hold very well.

According to Stewart, this is because the potential of liquidation, recovery,

recapitalization, or takeover sets a floor on a company’s market value (Stewart p.217).

For example with companies which have a lot of fixed assets this is quite easy to

understand. Market value will always reflect the value of assets even though the company

has very low or negative rate of return (and so theoretically it should sell a lot below

book value). That is because the company can always be liquidated; the owners have an

option to liquidate the assets if the return looks week also in the future. On the other hand

markets do not believe that the weak returns can go on forever. Markets are expecting a

chance, an improvement, in the long run. If EVA is positive, the relationship is more

direct. Then the market valuation happens on the basis of return and growth potential and

not on the basis of liquidation or recovery value. Stewart finds also that MVA and EVA

correspond each other best when we talk about changes in EVA and MVA and not the

absolute levels. Changes in EVA and MVA are not affected so much by accounting

distortions and inflation than the absolute values.

Grant (1996) shows that EVA significantly impacts the market value added of a firm and

that this wealth effect stems from the company’s positive residual return on capital. He

calculates regression statistics between the MVA-to-capital and EVA-to-capital ratios

from the data of 983 firms.



Peterson (1996) show that value-added measures are slightly but not significantly more

correlated with stock returns than traditional performance measures.

Lehn and Makhija (1996) study EVA and MVA as performance measures and signals for

strategic change. Their data consists of 241 U.S. companies and cover years 1987, 1988,

1992 and 1993. The researchers first find out that both measures correlate positively with

stock returns and that the correlation is slightly better than with traditional performance

measures like return on assets (ROA), return on equity (ROE) and return on sales (ROS).

Additionally they study how companies’ performance, as measured in terms of EVA and

MVA, affect on the CEO firings. Finally they examine the relationship between

EVA/MVA and corporate focus. Lehn and Makhija find an inverse relation between

EVA/MVA and abnormal CEO turnover. They also find that firms with greater focus on

their business activities have significantly higher MVA than their less focused

counterparts. Lehn and Makhija conclude that their results suggest EVA and MVA to be

effective performance measures that contain information about the quality of strategic

decisions and serve as signals of strategic change.



Chapter-3



METHODOLOGY STUDY TYPE: The study type is analytical, quantitative and historical.

Analytical as facts and existing information is used for the analysis.

Quantitative as EVA is calculated and the variables are expressed in measurable terms.

Historical as the historical information is used for analysis and interpretation.

SAMPLE TECHNIQUE: The Sampling method used here is Non-Probability Sampling. Companies listed in the

stock exchange are considered for the sample because market prices and other

information are available. Since NIFTY is a good proxy for the whole market, so

companies will be selected from the NIFTY Index.

SAMPLE SIZE: Sample includes 20 companies in the NIFTY (for which relevant data was available), for

a period of 5 years starting from FY 2001-02 to FY 2005-06. The following are the

sample 20 companies:

1. Associated Cement Companies Ltd.

2. Bajaj Auto

3. Bharat Heavy Electricals Ltd.

4. Bharat Petroleum Corporation Ltd.

5. Cipla Ltd.

6. Dabur

7. Dr. Reddy’s Laboratories Ltd.

8. Hero Honda Motors

9. Hindustan Lever Ltd.

10. ITC Ltd.

11. Infosys Technologies Ltd.

12. Larsen & Tourbo Ltd.



13. Maruti Udyog

14. Oil & Natural Gas Corporation

15. Ranbaxy Laboratories Ltd.

16. Reliance Industries

17. Satyam Computers

18. Tata Consultancy Services

19. Tata Motors

20. Wipro Ltd.

DATA COLLECTION:

Data type: Secondary data

Data Content: Historical share prices of the sample companies.

Index values of S&P CNX 500.

Financial Information of the sample companies.

Data Source: Historical share prices of the sample companies and the index points for the period has

been taken from the database of Capital Market Publishers (India) Ltd., Capitaline 2000

as well as from nseindia.com. Financial statements of the sample companies have also

been taken from the same source.



METHOD ADOPTED TO CALCULATE ECONOMIC VALUE ADDED (EVA):

EVA = NOPAT-WACC*CAPITAL EMPLOYED

NOPAT is net operating profit after taxes.

WACC is weighted average cost of capital (equity and debt). WACC used in the

calculations is at book value of equity and debt. It is calculated as follows:

WACC = Ke *W1+ Kd (1-T)*W2

W1 is weight of EQUITY

W2 is weight of DEBT

Kd is the effective cost of Debt, which is calculated by dividing the totat

interest by the total debt.

Ke is calculated using the Capital Asset Pricing Model developed by Modigliani and

Miller.

Ke=Rf+Beta (Rm-Rf)

Rf is the risk free rate, i.e., the rate of interest for 1-year government

securities. These rates are obtained from the website of Reserve Bank

of India.

Rm is the return for the market. It is calculated by using the formula given below for the

index values.

Rm=Average of return on market for all the 10 years

Return = Closing index value-opening index value * 100/Opening index value

Beta values for all the sample companies for all the 5 years are calculated by finding the

slope between log normal of share prices of all the companies and log normal of the

index values. Log normal of the values is considered to remove abnormalities if any and

convert them into normal distribution.

Invested Capital is the total long term funds and includes equity shares and the total debt

as at the end of the year.



Chapter-4



DATA ANALYSIS AND INTERPRETATION

TABLE-1

The following table shows the calculated beta of sample companies for

the period of 2002 to 2006:

BETA OS SAMPLE COMPANIES:

2006 2005 2004 2003 2002 Infosys 0.3546 0.152979 -0.04411 0.00557 -0.01655 Wipro 0.292279 0.297731 0.349974 0.188693 0.174759

TCS 0.3510 0.3674 0.1664 0.1298 0.1115

Satyam 0.406208 0.401593 0.193428 0.195075 0.176145 Maruti Udyog 0.4456 0.3870 0.3349 0.2281 0.1156 Tata Motors 0.509645 0.557892 0.511727 0.362388 0.30271 Bajaj Auto 0.420812 0.438884 0.352684 0.185454 -0.12573 Hero Honda 0.435857 0.164088 0.140313 0.136568 0.169832 HLL 0.471316 0.525848 0.579891 0.841632 0.926359 ITC 0.646798 0.618266 0.576269 0.580617 0.520053 Dabur 0.481458 0.552343 0.607186 0.382696 0.349168 L&T 0.320191 0.633972 0.572677 0.45041 0.378928 ACC 0.531201 0.606884 0.43202 0.358689 0.288628 BHEL 0.436836 0.487245 0.499585 0.277344 0.191105 RIL 0.497087 0.634151 0.321646 0.392903 0.271334 ONGC 0.34848 0.299664 0.346486 0.352947 0.406132 BPCL 0.38585 0.269347 0.188172 0.161034 0.130788 Ranbaxy 0.428494 0.140275 0.145339 0.169551 0.396663 Cipla 0.510034 0.520426 0.375294 0.178704 0.158716 Dr. Reddys 0.346703 0.134656 -0.05817 0.065163 0.079722



TABLE-2

The following table shows the NOPAT of selected companies during the

period of 2002-2006:

NET OPERATING PROFIT AFTER TAX (NOPAT):

2006 2005 2004 2003 2002

Infosys 2271.5 1753.5 1110.623 875.4655 718.0875

Wipro 1883.161 1501.619 912.639 722.8195 717.444

TCS 2658.404 1790.096 5.9865 1.2155 N. A.

Satyam 1044.036 660.387 478.1985 342.6085 272.1355 Maruti Udyog 1471.4 1286.53 868.335 426.985 349.83

Tata Motors 2297.351 1830.682 1363.7 844.3955 442.6435

Bajaj Auto 1239.616 935.641 754.2925 628.628 559.0455

Hero Honda 1070.846 915.992 745.8815 617.292 485.485

HLL 1231.545 1298.192 1562.236 1550.848 1387.328

ITC 2604.189 2459.723 1754.812 1563.088 1335.932

Dabur 201.033 151.585 106.8145 105.17 95.4915

L&T 1163.498 1046.017 632.424 688.0575 733.0245

ACC 636.839 573.804 400.7315 302.783 314.5675

BHEL 2008.279 1317.295 827.3135 677.6315 603.8565

RIL 10817.63 10028.82 7150.358 6025.065 5920.876

ONGC 18786.83 16569.22 10616.09 10986.42 7070.934

BPCL 1485.491 2872.072 3196.193 2719.34 1880.996

Ranbaxy 259.644 705.46 725.53 609.843 292.838

Cipla 564.263 406.924 291.3235 224.471 217.4835

Dr. Reddys 301.966 107.611 246.2655 320.3915 345.15



TABLE-3

The following table shows the Total Capital Employed of selected

companies during the period of 2002-2006:

TOTAL CAPITAL EMPLOYED (EQUITY FUND + DEBT FUND):

2006 2005 2004 2003 2002

Infosys 6966 5225 3249.58 2857.49 2080.31

Wipro 6680.96 5343.51 3860.29 3536.41 2624.06

TCS 6115.5 3680.55 488.26 36.84 N. A.

Satyam 4418.18 3316.59 2661.7 2217.67 1975.16Maruti Udyog 6242.6 4803.6 3986.7 3554 3363.3

Tata Motors 9510.61 7111.36 5350.26 4009.66 4976.3

Bajaj Auto 7144.34 5807.06 4946.09 4236.56 3486.07

Hero Honda 2195.11 1695.14 1313.51 995.31 802.2

HLL 2288.13 3742.27 3891.2 3777.27 3230.89

ITC 9181.21 8140.97 6530.91 5650.16 4698.52

Dabur 601.39 514.81 410.6 630.86 699.36

L&T 8463.17 6769.76 5416.54 7917.45 8115.54

ACC 3334.88 3277.39 2947.8 2670.71 2709.72

BHEL 7859.62 6563.87 5835.97 5337.89 5135.41

RIL 74370.83 59910.76 56034.32 50318.2 46926.1

ONGC 71869.71 60774.37 55624.41 42071.69 33233.02

BPCL 19187.3 13203.78 11261.21 10937.45 10543.17

Ranbaxy 4450.99 3360.47 2741.15 2177.58 2067.65

Cipla 2452.18 1744.83 1474.63 1164.86 924.03

Dr. Reddys 5185.79 2222.2 2007.76 1768.39 1428.87



TABLE-4

The following table shows the WACC of selected companies during the


WEIGHT AVERAGE COST OF CAPITAL:

2006 2005 2004 2003 2002

Infosys 23.95 13.74978 2.468405 6.425512 6.22

Wipro 20.65 12.46592 37.49863 3.965674 3.706979

TCS 23.32 12.99626 2.120275 4.76447 N. A.

Satyam 25.67 13.98304 24.131 3.911132 4.034106Maruti Udyog 25.32 13.37678 34.76259 3.970437 5.081238

Tata Motors 21.34 12.70353 39.12789 6.648945 6.981656

Bajaj Auto 21.28 11.595 30.85732 3.237675 6.376151

Hero Honda 25.64 8.782083 16.84032 4.156126 3.322146

HLL 28.65 11.81722 35.4589 -4.42524 -5.89429

ITC 37.09 15.26988 58.47004 -0.65914 0.316923

Dabur 23.85 9.323024 45.61707 3.605058 4.122739

L&T 14.43 10.12468 30.27125 2.312099 3.594039

ACC 22.12 11.19154 24.60122 4.117138 4.575137

BHEL 25.92 15.14266 48.00732 3.178827 4.239266

RIL 21.55 14.15315 24.10534 2.769184 3.959447

ONGC 18.82 10.02115 28.81652 1.700393 1.004354

BPCL 14.03 8.108671 15.29107 4.952546 5.49838

Ranbaxy 15.37 7.757425 16.15997 4.617624 2.914775

Cipla 25.24 8.070181 35.57109 4.026319 4.02599

Dr. Reddys 10.24 8.627416 1.305751 5.756608 5.673527



INTERPRATION TABLE-1

It can be seen that beta for most of the companies has increased from year to

year from Table-1. Earlier, in 2002 it was in range between “0.10 to 0.20” except

some cases. But slowly it has increased to about 0.50 by the end of 2006. Thus

we can say that riskiness of the stock is increased during the period of 2002 to

2006.

TABLE-2

NOPAT is increased consistently increased and improved from year to year of

almost companies. There is some variations in case of pharmacy companies. In

2006, NOPAT of Ranbaxy has dropped, while in case of Dr. Reddy’s NOPAT has

decreased continuously but in year 2006 it has improved a lot.

TABLE-3

Total capital employed of almost companies is increased consistently from

2002 to 2006. While, HLL has reduced its capital fund in year 2005 and

2006. L&T has also reduced its capital fund during 2003 and 2004 but it has

again increased the capital fund in 2005 and 2006.

TABLE-4

From the table it is concluded that weightage average cost of capital

(WACC) of the all companies during 2002 and 2003 is very low. WACC is

around 2-6 during these years. But in 2004 WACC is increased drastically

because of increasing beta and market return as well as. In case of Infosys

and Dr. Reddy’s, WACC is very low because of negative beta. And in case

of TCS, WACC is also very low because it depended more on debt fund



TABLE-5

The following table shows the EVA of selected companies during the


EVA OF SAMPLE COMPANIES (in rs. crore)

2006 2005 2004 2003 2002

Infosys 602.8215 1035.074 1030.41 691.8571 588.6936

Wipro 503.6009 835.5013 -534.917 582.577 620.1707

TCS 1232.47 1311.762 -4.36595 -0.53973 N. A.

Satyam -89.9553 196.6269 -164.096 255.8725 192.46 Maruti Udyog -109.532 643.9632 -517.545 285.8757 178.9327 Tata Motors 267.3399 927.2883 -729.744 577.7954 95.21535

Bajaj Auto -280.662 262.3122 -771.938 491.462 336.7684 Hero Honda 508.11 767.1234 524.6822 575.9257 458.8347

HLL 576.0827 855.9597 182.4592 1718.001 1577.765

ITC -801.572 1216.607 -2063.81 1600.33 1321.041

Dabur 57.59015 103.5891 -80.4892 82.42713 66.65871

L&T -57.9097 360.6007 -1007.23 504.9982 441.3488

ACC -100.672 207.0137 -324.463 192.8262 190.5941

BHEL -28.9498 323.3506 -1974.38 507.9492 386.1528

RIL -5210.28 1549.555 -6356.91 4631.661 4062.862

ONGC 5262.658 10478.93 -5412.93 10271.03 6737.157

BPCL -1206.64 1801.421 1474.233 2177.658 1301.292

Ranbaxy -424.617 444.7741 282.5611 509.2905 232.5707

Cipla -54.6487 266.1131 -233.219 177.57 180.2821

Dr. Reddys -228.956 -84.1074 220.0491 218.5922 264.0827



INTERPRATION:

It can be understood from Table 5 that there is no consistent pattern of economic

value created by the selected companies. Sometimes, it is negative and some

time it is positive.

In year 2002, Economic Value added of all the companies is positive. in the next

year 2003, EVA of the most companies is increased in comparison of previous

year except Wipro, ONGC, Cipla and Dr. Reddys. EVA of these four companies

is decreased compare to previous year. While, EVA of TCS is negative.

In year 2004, EVA of the companies is the combination of positive and negative.

In the year, only Infosys, Hero Honda, HLL, BPCL, Ranbaxy and Dr. Reddy’s

added economic value while all other companies did not create any wealth to

their shareholders because of high market return.

Again in 2005, all selected companies created wealth except Dr. Reddy’s

In year 2006, economic value added is again combination of positive and

negative like in year 2004. The companies, those created value to shareholders

are Infosys, Wipro, TCS, Tata Motors, Hero Honda, HLL, Dabur and ONGC.

Except these companies no other companies added any economic value.

Infosys, Hero Honda and HLL are the companies among all sample companies,

those created wealth to its shareholders consistently during five years from 2002-

2006.



TABLE-6: EVA and Market Price of the sample companies 2002-2006

2002 2003 2004 2005 2006

INFOSYS Adjusted Market Price 5770.10 6678.15 10362.50 11142.50 14617.50

EVA 588.69 691.86 1030.41 1035.07 602.82

WIPRO Adjusted Market Price 2732.75 2674.15 3769.50 3397.80 5347.75

EVA 620.17 582.58 -534.92 835.50 503.60

TCS Adjusted Market Price N. A. N. A. N. A. 1413.00 1848.63

EVA N. A. -0.54 -4.37 1311.76 1232.47

SATYAM Adjusted Market Price 695.63 876.25 1042.25 1014.75 2033.50

EVA 192.46 255.87 -164.10 196.63 -89.96

TATA MOTORS

Adjusted Market Price 164.85 433.75 494.95 447.95 878.53

EVA 95.22 577.80 -729.74 927.29 267.34

BAJAJ AUTO


EVA 336.77 491.46 -771.94 262.31 -280.66

HERO HONDA


EVA 458.83 575.93 524.68 767.12 508.11

HLL Adjusted Market Price 1767.50 1943.50 1480.50 1404.00 2587.00

EVA 1577.77 1718.00 182.46 855.96 576.08

ITC Adjusted Market Price 445.65 632.10 863.00 883.45 1868.00

EVA 1321.04 1600.33 -2063.81 1216.61 -801.57

DABUR Adjusted Market Price 444.60 812.10 891.00 1250.40 1178.75

EVA 66.66 82.43 -80.49 103.59 57.59



Continued…..

L&T Adjusted Market Price 203.50 499.00 955.58 1057.51 N. A.

EVA 441.35 505.00 -1007.23 360.60 -57.91

ACC Adjusted Market Price 1610.75 2376.00 3118.75 3655.00 7114.00

EVA 190.59 192.83 -324.46 207.01 -100.67

BHEL Adjusted Market Price 165.83 471.43 656.75 812.08 2137.53

EVA 386.15 507.95 -1974.38 323.35 -28.95

RIL Adjusted Market Price 294.30 508.90 510.01 569.95 633.00

EVA 4062.86 4631.66 -6356.91 1549.55 -5210.28

ONGC Adjusted Market Price 241.12 473.64 558.69 609.37 822.06

EVA 6737.16 10271.03 -5412.93 10478.93 5262.66

BPCL Adjusted Market Price 212.95 413.45 432.13 387.50 414.05

EVA 1301.29 2177.66 1474.23 1801.42 -1206.64

RANBAXY Adjusted Market Price 284.54 546.28 595.70 523.63 424.10

EVA 232.57 509.29 282.56 444.77 -424.62

CIPLA Adjusted Market Price 689.20 967.60 1193.30 1091.00 2427.90

EVA 180.28 177.57 -233.22 266.11 -54.65

DR. REDDY'S


EVA 264.08 218.59 220.05 -84.11 -228.96



INTERPRATION:

From the table it can be understood that there is no such relationship

between price and EVA. Because increase or decrease in EVA, there is no

relative effect on market price of shares of companies. Market price does not

vary with the variation of economic value added of the companies.

Especially in 2004 and 2006 when companies did not created any wealth to

its shareholders, market price of the companies was not influenced

negatively.

Market price of Infosys has increased consistently in stead of negative EVA

in 2006. Price of Wipro and Satyam is also increased consistently in stead of

negative EVA in 2004 and 2006.



Chapter-5



DISCUSSIONS:

Economic Value Added is a residual income variable. It is defined as Net

operating profit after taxes subtracted with the cost of capital tied in operations.

EVA seems to have importance for companies as a performance measurement

and controlling tool. First of all it is fairly simple measure but still measures well

the ultimate aim of any given company, the increase or decrease in shareholders’

wealth. Maximizing traditional performance measures like ROI is not theoretically

in line with maximizing the wealth of shareholders. Therefore EVA is superior to

conventional performance measures. The premise behind EVA – that businesses

must cover their capital costs – is neither new nor peculiar. Putting it into practice

can still be eye-opening. EVA shows financial performance with a new pair of

glasses or offers new approach especially for the companies where equity is

viewed as free source of funds and performance is measured by some earnings

figure. At best EVA helps with creating a mind-set throughout the organization

that encourages managers and employees to think and behave like owners.

Substantial shareholder value increases and true success stories arise always

from outstanding strategy, quick response, great ideas and good predicting of

future. EVA helps in quantitative assessing of different strategies but that is all.

Wealth does not arise from EVA alone. EVA only measures changes of wealth. It

is also as short-term as all other periodic performance measures. Therefore all

companies should rely also on other performance measures. Especially

important this is e.g. for new growth phase companies. However we have to bear

in mind that the success or failure of any given company is measured ultimately

as created shareholder value. Therefore EVA is important measure also for those

companies that use primarily other tools is assessing the achievement of their

strategic goals.



Conclusion The above discussion explains the importance of using EVA as a tool for

measuring financial performance. The study reveals that there is no strong

pattern of EVA of selected companies during the period. The wealth created by

most companies in year 2004 and 2006 is negative because of higher cost of

capital than that of other years.

The central idea of EVA is subtracting the cost of capital from the firm's profits to

measure, as the term indicates, the economic additional value produced by the

firm to its owners over the weighted cost of the capital employed. This raised the

question of the effect of the debt and equity cost components on the behavior of

EVA. It was observed that the cost of debt has little effect on the EVA's. On the

other hand, as is expected, EVA behaves in a linear fashion with respect to the

cost of equity. It was also observed that even EVA is much more unstable than

the other performance measure.

It is also observed that there is no strong relation between EVA and market

prices of the companies. Thus, it can be understood that investor do not give so

importance to EVA for its investment decision. Extensive study is required to

establish the influence of other factors like non-fund based income, spread,

deployment of funds, market price, etc. It is also expected that the usage of EVA

as a financial performance tool will also be more in India.



Chapter-6



BIBLIOGRAPHY: TEXT BOOKS: Financial Management, Theory and Practice Prasanna Chandra (Sixth Edition) Research Methodology Donald Cooper and Pamela Schindler (Eighth Edition) WEBSITES: www.nseindia.com www.rbi.org.in www.capitaline.com www.investopedia.com



REFERENCES: 1. ARTICLES OF ICFAI (The Institute of Chartered Financial Analysts of India): “Computation of EVA in Indian Banks”, by Roji George, the ICFAI Journal of Bank Management, Vol IV, No. 2 , May 2005, Pg No. 30-44.

2. A Review and Synthesis of the Economic Value-Added Literature, Andrew Worthington, Tracey West

3. Database ofCapital Market Publishers (India) Ltd., Capitaline 2000



Chapter-6



ANNEXURE COMPUTATION OF EVA OF SAMPLE COMPANIES DURING

PERIOD OF 2002 TO 2006:

2006

COMPANY EBIT NOPAT WACC EVA Infosys 3245 2271.5 1668.68 602.82 Wipro 2690.23 1883.161 1379.56 503.60 TCS 3797.72 2658.404 1425.93 1232.47 Satyam 1491.48 1044.036 1133.99 -89.96 Maruti Udyog 2102 1471.4 1580.93 -109.53 Tata Motors 3281.93 2297.351 2030.01 267.34 Bajaj Auto 1770.88 1239.616 1520.28 -280.66 Hero Honda 1529.78 1070.846 562.74 508.11 HLL 1759.35 1231.545 655.46 576.08 ITC 3720.27 2604.189 3405.76 -801.57 Dabur 287.19 201.033 143.44 57.59 L&T 1662.14 1163.498 1221.41 -57.91 ACC 909.77 636.839 737.51 -100.67 BHEL 2868.97 2008.279 2037.23 -28.95 RIL 15453.75 10817.625 16027.91 -5210.28 ONGC 26838.33 18786.831 13524.17 5262.66 BPCL 2122.13 1485.491 2692.13 -1206.64 Ranbaxy 370.92 259.644 684.26 -424.62 Cipla 806.09 564.263 618.91 -54.65 Dr. Reddys 431.38 301.966 530.92 -228.96



2005 COMPANY EBIT NOPAT WACC EVA

Infosys 2505 1753.5 718.43 1035.07 Wipro 2,145.17 1501.619 666.12 835.50 TCS 2,557.28 1790.096 478.33 1311.76 Satyam 943.41 660.387 463.76 196.63 Maruti Udyog 1,837.90 1286.53 642.57 643.96 Tata Motors 2,615.26 1830.682 903.39 927.29 Bajaj Auto 1,336.63 935.641 673.33 262.31 Hero Honda 1,308.56 915.992 148.87 767.12 HLL 1,854.56 1298.192 442.23 855.96 ITC 3,513.89 2459.723 1243.12 1216.61 Dabur 216.55 151.585 48.00 103.59 L&T 1,494.31 1046.017 685.42 360.60 ACC 819.72 573.804 366.79 207.01 BHEL 1,881.85 1317.295 993.94 323.35 RIL 14,326.88 10028.816 8479.26 1549.55 ONGC 23,670.31 16569.217 6090.29 10478.93 BPCL 4,102.96 2872.072 1070.65 1801.42 Ranbaxy 1,007.80 705.46 260.69 444.77 Cipla 581.32 406.924 140.81 266.11 Dr. Reddys 153.73 107.611 191.72 -84.11


Infosys 1708.65 1110.6225 80.21 1030.41 Wipro 1,404.06 912.639 1447.56 -534.92 TCS 9.21 5.9865 10.35 -4.37 Satyam 735.69 478.1985 642.29 -164.10 Maruti Udyog 1,335.90 868.335 1385.88 -517.54 Tata Motors 2,098.00 1363.7 2093.44 -729.74 Bajaj Auto 1,160.45 754.2925 1526.23 -771.94 Hero Honda 1,147.51 745.8815 221.20 524.68 HLL 2,403.44 1562.236 1379.78 182.46 ITC 2,699.71 1754.8115 3818.63 -2063.81 Dabur 164.33 106.8145 187.30 -80.49 L&T 972.96 632.424 1639.65 -1007.23 ACC 616.51 400.7315 725.19 -324.46 BHEL 1,272.79 827.3135 2801.69 -1974.38 RIL 11,000.55 7150.3575 13507.26 -6356.91 ONGC 16,332.45 10616.0925 16029.02 -5412.93 BPCL 4,917.22 3196.193 1721.96 1474.23 Ranbaxy 1,116.20 725.53 442.97 282.56 Cipla 448.19 291.3235 524.54 -233.22 Dr. Reddys 378.87 246.2655 26.22 220.05




Infosys 1346.87 875.4655 183.61 691.86 Wipro 1,112.03 722.8195 140.24 582.58 TCS 1.87 1.2155 1.76 -0.54 Satyam 527.09 342.6085 86.74 255.87 Maruti Udyog 656.9 426.985 141.11 285.88 Tata Motors 1,299.07 844.3955 266.60 577.80 Bajaj Auto 967.12 628.628 137.17 491.46 Hero Honda 949.68 617.292 41.37 575.93 HLL 2,385.92 1550.848 -167.15 1718.00 ITC 2,404.75 1563.0875 -37.24 1600.33 Dabur 161.8 105.17 22.74 82.43 L&T 1,058.55 688.0575 183.06 505.00 ACC 465.82 302.783 109.96 192.83 BHEL 1,042.51 677.6315 169.68 507.95 RIL 9,269.33 6025.0645 1393.40 4631.66 ONGC 16,902.18 10986.417 715.38 10271.03 BPCL 4,183.60 2719.34 541.68 2177.66 Ranbaxy 938.22 609.843 100.55 509.29 Cipla 345.34 224.471 46.90 177.57 Dr. Reddys 492.91 320.3915 101.80 218.59


Infosys 1,104.75 718.0875 129.39 588.69 Wipro 1,103.76 717.444 97.27 620.17 TCS #VALUE! #VALUE! Satyam 418.67 272.1355 79.68 192.46 Maruti Udyog 538.2 349.83 170.90 178.93 Tata Motors 680.99 442.6435 347.43 95.22 Bajaj Auto 860.07 559.0455 222.28 336.77 Hero Honda 746.9 485.485 26.65 458.83 HLL 2,134.35 1387.3275 -190.44 1577.77 ITC 2,055.28 1335.932 14.89 1321.04 Dabur 146.91 95.4915 28.83 66.66 L&T 1,127.73 733.0245 291.68 441.35 ACC 483.95 314.5675 123.97 190.59 BHEL 929.01 603.8565 217.70 386.15 RIL 9,109.04 5920.876 1858.01 4062.86 ONGC 10,878.36 7070.934 333.78 6737.16 BPCL 2,893.84 1880.996 579.70 1301.29 Ranbaxy 450.52 292.838 60.27 232.57 Cipla 334.59 217.4835 37.20 180.28 Dr. Reddys 531 345.15 81.07 264.08

51396384 Economic Value Added EVA of Sample Companies

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