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Definition of EVA
EVA essentially seeks to measure a company's actual
rate of return as against the required rate of return.
To put it simply, EVA is the difference between Net
Operating Profit after Tax (NOPAT) and the capital
charge for both debt and equity (overall cost of
capital). If NOPAT exceeds the capital charge, EVA
is positive and if NOPAT is less than capital charge,
EVA is negative.
The definition of EVA can be mathematically shown
as below:
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Invested Capital
Depreciation
NOPAT
200
75
90
15
2
3
4
5
120
130
145
130
49.5
27.23
14.97
8.24
70.5
102.77
130.03
121.76
(10.06)*
Cash Flows
EVA (Method)
P V o f Cash
Flows
NOPAT
Invested
Capital
Cost of
Capital
EVA
PV of EVA
-200
-200
75
63.56
-15
200
36
-51
-43.22
120
86.18
70.5
110
19.8
50.7
36.41
130
79.12
102.77
60.5
10.89
91.88
55.92
145
74.79
130.03
33.27
5.99
124.04
63.98
140.06
61.22
121.76
18.30
3.29
118.47
51.78
164.87
164.87
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Previous Studies
The empirical research of academics to date on this
subject is limited. The results of these studies are
mixed. Stewart (1991) has first studied the relationship with market data of 618 US companies. Stewart
observed that the relationship between EVA and
MVA is highly correlated among US companies.
Lehn and Makhija (1996) in their study of 241 US
companies over two periods (1987-1988 and 19921993) observed that both measures (EVA and MVA)
correlate positively with stock returns and that the
correlation is slightly better with EVA than that with
traditional performance measures like return on
assets (ROA), return on equity (ROE), etc. On the
predictive power of EVA in explaining MVA or
shareholder wealth, several researchers (for example,
Uyemura, Kantor and Petit, 1996; McCormack and
Vytheeswaran, 1998; O'Byrne, 1996; Milunovich
and Tsuei, 1996; Grant, 1996) observed that EVA
is better correlated with MVA or shareholder wealth
than other traditional parameters like ROCE, RONW,
EPS, etc. However, there are adverse findings too.
Dodd and Chen (1996) found that return on assets
(ROA). explained stock returns better than EVA.
Hamel (1997) was critical about the superiority of
EVA. He opined that EVA reveals little about a
company's share of new wealth creation.
MVA = Market Capitalization - Equity Share Capital + Reserves and Surplus - Revaluation
Reserves-Accumulated Losses - Miscellaneous Expenditure.
................ (Eq-9)
It can be observed from the above modified
definition that MVA is almost similar to market pricebook value (p/b) ratio. The only difference is that
MVA is an absolute measure and p/b ratio is a
relative measure. If MVA is positive, it implies that
p/b is greater than one. Negative MVA implies a
less than one p/b ratio. Successful companies add
their MVA and thus increase the value of capital
invested in the business. It is argued that MVA
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Research Methodology
SBI's PLR(%)
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
19.0
19.0
15.0
16.5
14.5
14.0
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Sample Selection
EVA improvements (DEVA). Thus the above equation shows that if a firm has no future growth
prospect, its market value would be largely dependent on current operational value. On the other hand,
a growth firm would derive its market value mostly
from future growth value. Therefore, a look at the
value of COV and FGV would tell us whether the
firm in question has market-perceived growth potential.
Computational Methodology
Beginning
Invested
Capital
Current
EVA
(94-93)
Current
Future
Current
WACC
Returns(r) Operational
(94-93)(%) (%)
Value
Incremental
EVA
(Rs Crore)
Future
Growth
Value
Abbott Laboratories
1993-94
1994-95
1995-96
1996-97
1997-98
HINDALCO
1993-94
1994-95
1995-96
1996-97
1997-98
12.85(end
1.16
of 1993-94)
12.85
15.04
23.93
20.73
12.22
1188.96
1188.96
1919.22
2457.70
2840.07
15.79
49.95
22.34
24.25
1.33
18.01
22.72
1.55-1.16=0.39
-1.64-1.55=-3.19
1.39+1.64=3.02
2.18-1.39=0.79
4.15
130.77-49.95=80.82
133.12-130.77=2.35
15.06- 133.12=-118.04
103.08-15.06=88.02
326.01
1505.21
26.79
22.73
16.41
19.42
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= COV + FGV + e
= 22.34 -I- 4.15 + e .........(Eq.14)
COV
FGV
1.000
0.821
-0.279
COV
0.821
1.000
-0.592
FGV
-0.279
-0.592
1.000
Regression Results
MV = 63.578 + 2.057 * COV + 0.986 * FGV
(1.101)
(22.380***)
(7.047***)
Note: Figures in parenthesis indicate t-statistic.
*** indicates significance at 1 per cent level.
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COV
Ashok Leyland
Hindustan Lever
Ltd. (HLL)
Procter & Gamble
India Ltd. (P&G)
TISCO
Wipro Ltd.
FGV
Market Value
788.27
-598.65
2282.15
958.08
1976.42
7562.65
41.73
3866.62
112.22
133.02
-594.24
218.68
717.71
10296.28
82.46
Conclusion
However, Appendix 1 also reveals a darker side.
There exists a huge gap in many cases between actual
market value and the sum total of COV and FGV.
For example, in case of HLL, the market value (end
of 1993-94) was Rs 7562.65 crore and the FGV was
only Rs 1976.42 crore. It implies that FGV has failed
in these cases to capture the growth potential
factored in the market value of HLL. Another
possible explanation for FGVs poor predictive power
could be that FGVs are calculated here on the basis
of actual operating results of the firms during the
period 1994-95 to 1997-98. A longer time horizon
and calculation of FGV on the basis of expected
future EVAs might produce a better relationship
between FGV and market value. The market capitalization factors in a longer time horizon and
capilatizes the growth potential of a firm during the
future period. Computing FGV only on the basis
of four-year data (1994-95 to 1997-98) might have
led to underestimation of future growth potential.
We have not attempted here to estimate future EVAs
simply because that exercise would involve more
assumptions. In the absence of published information about equity analysts' future projections of firms'
performance, it would have been very difficult to
estimate economic parameters .of these 200 sample
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COV
(1994)
FGV
Company Name
MV
(1994)
Ceat Ltd.
Century Textiles & Inds. Ltd.
Cheminor Drugs Ltd.
Cimmco Birla Ltd.
Cipla Ltd.
Clutch Auto Ltd.
Colgate-Palmolive (India) Ltd.
D C W Ltd.
Dalmia Cement (Bharat) Ltd.
Deccan Cements Ltd.
Denso India Ltd.
Dewan Rubber Inds. Ltd.
Dr. Reddy'S Laboratories Ltd.
Duphar-Interfran Ltd.
E I D-Parry (India) Ltd.
E Merck (India) Ltd.
East Coast Steel Ltd.
Elgitread (India) Ltd.
Escorts Ltd.
Essar Steel Ltd.
Eurotex Industries &
Exports Ltd.
Falcon Tyres Ltd.
Finolex Cables Ltd.
Forbes Gokak Ltd.
Fulford (India) Ltd.
G K N Invel Transmissions
Ltd.
G S L (India) Ltd.
Gabriel India Ltd.
Gajra Bevel Gears Ltd.
German Remedies Ltd.
Godfrey Phillips India Ltd.
Goetze (India) Ltd.
Gontermann-Peipers (India)
Ltd.
Goodricke Group Ltd.
Goodyear India Ltd.
Govind Rubber Ltd.
Grasim Industries Ltd.
Greaves Ltd.
Gujarat Ambuja Cements Ltd.
Gujarat Lyka Organics Ltd.
Hardcastle & Waud Mfg.
Co. Ltd.
COV
(1994)
534.13
1582.42
112.07
174.50
281.45
28.30
409.41
175.33
120.25
29.41
23.29
124.55
330.07
31.11
192.51
385.12
34.67
38.86
267.25
4095.27
FGV
MV
(1994)
54.65 854.13
1594.72 1140.23
-37.38 170.26
-84.20 138.06
545.43
91.03
-3.45 32.91
-2.08 6416.90
-108.60 263.03
-46.91 296.33
10.05 42.16
10.06 105.68
-74.42 121.58
81.64 291.15
-14.66 59.28
-186.60 370.14
207.11 297.95
-24.22
32.44
18.24 36.20
-113.41 514.15
3449.07 4075.24
35.62
26.95
269.29
139.64
13.80
34.89
94.06
72.65
11.10
129.11
107.29
87.40
25.75
88.65
77.05
69.30
2398.06
230.28
914.55
79.60
11.33
-5.41
72.97
13.67
254.20
427.87
35.98
97.35
89.26
104.10
22.49
263.15
349.13
127.99
20.62
438.41
107.10
111.66
5573.31
365.35
991.73
26.39
15.99
(Appendix 1 Contd.)
Vol. 25, No. 3, July-September 2000
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Company Name
COV
(1994)
FGV
MV
(1994)
Company Name
COV
(1994)
T I L Ltd.
54. 94
28 .21
74.14
T T K Pharma Ltd.
TVS Srichakra Ltd.
Talbros Automotive
Components Ltd.
Tata Chemicals Ltd.
Tata Engineering &
Locomotive Co. Ltd.
Tata Infotech Ltd.
Tata Iron & Steel Co. Ltd.
Tata Tea Ltd.
Tata-Yodogawa Ltd.
66.67
15. 34
1 .36
9 .31
65.06
17.48
265 .16
497.87
86. ,56
361. 08
51. 95
46.
75.
112.
8.
254. 44
103. ,56
41.57
-6. ,82
10, ,7
5 .36
12.90
2204 .1 851 .43 4277.06
1774.
80.
3866.
552.
32
32. ,0 23 .37
194 .1 -161 .11
46. 44
-21.51
97.43 9 .76
50.24
198.44
33.08
126.14
FGV
MV
(1994)
160.72 -88. 65
752.41
-30. 98 224.47
-114.68 669.74
51. 03 160.15
-194.52 729.51
28.15 327.02
29 19. 39
25 -55. 22
22 218. 68
39
-9.37
13.11
181.29
82.46
18.44
168.14 328.22
- 55 176.72
- 52 26.24
3. 34 96.03
References
Banerjee, A (1999). "Economic Value Added and Shareholder
Wealth: An Empirical Study of Relationship," Paradigm,
Vol 3, No 1, January-June.
O'Byrne, Stephen F (1996). "EVA and Market Value.Vournal of Applied Corporate Finance, Vol 9, No 3, Spring.
Rappaport, Alfred (1986). Creating Shareholder Value: The New
Standard for Business Performance, Chapter 5, First Edition,
New York: The Free Press.
Hamel, Gary (1997). "Killer Strategies that Make Shareholders Rich," Fortune, June 23.
Kondragunta, Chaith S (2000). "Winning with EVA," Business Today, February 22.
Lehn, K and Makhija, A K (1996). "EVA and MVA as Performance Measures and Signals for Strategic Change,"
Strategy and Leadership, Vol 24, May-June.
Wallace James S (1997). Adopting Residual Income Based Compensation Plans: Evidence of Effects on Managerial Actions,
Working Paper, University of California, USA.
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