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Transcript of Eva Mva - Copy
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Focused Finance
& EVA
Naina Adarsh
Tanvi Chaudhary Pushpak Roy
Manishwar
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EVA & Wealth Creation Warren Buffet:
“We feel noble intentions should be checked periodicallyagainst results. We test the wisdom of retaining earnings by
assessing whether retention, over time, delivers shareholdersat least $1 of market value for each $1 retained.”
Translation:
Ultimate test of any company’s success lies in increasingits market value by more than it increases its capital.
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View of the Firm
Value of firm = Value of Liabilities + Value of Equity That is the amount of invested capital
Market value of a company reflects:
Earning power of invested assets
Present value of current operations
Present value of expected improvement in operating performance.
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Market Valued Balance Sheet
Assets Liabilities
Equity
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What is Required to Focus?
Tie performance methods to capital budgeting
techniques:
Economic value added (EVA)
Market value added (MVA)
Want to gauge management’s performance
Focus on:
Decisions made in the past to help project the future.
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Links to
NPV
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Market Value Added
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Total
market
valueDebt &
equitycapital
Marketvalue added
Investment
In Company
Premium
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What is EVA?
EVA = Economic profit
Not the same as accounting profit
Difference between revenues and costs
Costs include not only expenses but also cost of capital
Economic profit adjusts for distortions caused byaccounting methods
Doesn’t have to follow GAAP
R&D, advertising, restructuring costs, ...
Cost of capital accounted for explicitly Rate of return required by suppliers of a firm’s debt and equity capital
Represents minimum acceptable return.
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What is Cost of Capital
Evaluation of profitability should also consider thelost opportunity that the capital has.
A company has Invested capital. This could make areturn elsewhere.
Before fully evaluating the profitability allowance for the cost of this capital should be considered.
This represents an opportunity cost .
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Market Value Added
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Total
market
valueDebt &
equitycapital
Expected
improvement
in EVA
MVA
Current level
of EVA
MVA = Present value of all future EVA
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Components of EVA
NOPAT Net operating profit after tax
Operating capital Net operating working capital, goodwill, and other
operating assets
Cost of capital Weighted average cost of capital %
Capital chargeCost of capital % * operating capital
Economic value added NOPAT less the capital charge.
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Explicit Vs. Implicit Costs
Explicit costs are direct attributable costs like
materials or labour used in production.
Implicit costs or otherwise known as opportunity
costs are those costs that are the result of losing an
alternative use.
Example: If I have € 1m to invest in a company, I
lose the opportunity to leave it in the bank earninginterest of say 5%.
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What is NOPAT?
Net sales 150,000
(-)Cost of sales 135,000
(-)Depreciation 2,000
(-)Selling &Admin exp 7,000
Net Operating profit 6,000
(-)Taxes @ 40% 2,400
NOPAT 3,600 Excludes financing charges
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What is Operating Capital?
Capital: Net operating assets adjusted for certain
accounting distortions
Asset write-downs, restructuring charges, …
Net operating assets: Cash, receivables, inventory, pre-paid expenses
Trade payable, accruals, deferred taxes
Net property, plant, and equipment
Exclude non-operating assets: Marketable securities, investments,...
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What is the Capital Charge?
Represents a rental charge for the use of the operating
capital
Minimum rate of return the operating capital should earn Calculated as the firm’s weighted average cost of capital % x
invested capital.
It represents the opportunity cost of capital
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Calculating EVA
NOPAT/Average capital
= Return on invested operating capital (ROIC)
- Weight average cost of capital (WACC)
= Spread (= ROIC - WACC)
* Operating capital
= Economic value added (EVA)
Net operating profit after tax (NOPAT)
- Capital charge (= WACC * Capital)
= Economic value added (EVA)
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What’s Affecting
EVA?
Sales
- Operating expenses
- Taxes
= NOPAT
- Capital charge
= EVA
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COGS, SG&A + Other
Potential gov’t actions
Market potential
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Forward Looking Relationship for
EVA & MVA
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EVA EVA EVA EVA
Year 1 Year 2 Year 3 .... Year n
Market
ValueMarket
value
MVA
Capital
=
EVA + EVA + EVA + ... + EVA
1 + r (1 + r)2 (1 + r)3 (1 + r)n
Market value is based on establishing theeconomic investment made in the company(capital), making a best guess about whateconomic profits (EVA) will happen in the
future, and discounting those EVAs to the present to get market value added.
MVA
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EVA Drives MVA
Companies that consistently earn profits in excess oftheir required return ...
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NOPATEVA
Market
Value
Capital
MVA
Charge
… are typically valued at premiums to book
value.
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Manufacturing EVA Drivers
Reduce inventory
Reduce cycle time
Improve yields
Reduce scrap/waste
Maximize labor efficiencies
Improve vendor efficiencies Process improvements
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Staff EVA Drivers
Work group/process simplification
Consistency “monitors” – audit
Centralizing resources/synergies
Best practices benchmarking
Insourcing/outsourcing decisions
Simplify EVA measurements/reporting Ensure compliance with legislation
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Marketing EVA Drivers
Increase market share / revenue
New markets
More focused channel programs
Voice of customer / consumer
Leverage advertising / promotion
Build brand awareness
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