Market value added
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Market Value Added (MVA) is the difference between the current market value of a firm and
the capital contributed by investors. If MVA is positive, the firm has added value. If it is
negative, the firm has destroyed value. The amount of value added needs to be greater than the
firm's investors could have achieved investing in the market portfolio, adjusted for the leverage
(beta coefficient) of the firm relative to the market.
The formula for MVA is:
MVA is market value added
V is the market value of the firm, including the value of the firm's equity and debt
K is the capital invested in the firm
MVA is the present value of a series of EVA values. MVA is economically equivalent to the
traditional NPV measure of worth for evaluating an after-tax cash flow profile of a project if the
cost of capital is used for discounting.
Economic Value Added
In corporate finance, Economic Value Added or EVA, is an estimate of a firm's economic profit
– being the value created in excess of the required return of the company's investors (being
shareholders and debt holders). Quite simply, EVA is the profit earned by the firm less the cost
of financing the firm's capital. The idea is that value is created when the return on the firm's
economic capital employed is greater than the cost of that capital. This amount can be
determined by making adjustments to GAAP accounting. There are potentially over 160
adjustments that could be made but in practice only five or seven key ones are made, depending
on the company and the industry it competes in.
1 Calculating EVA
2 Comparison with other approaches
3 Relationship to market value added
4 Integrating EVA and PBC
5 See also
7 External links
EVA is net operating profit after taxes (or NOPAT) less a capital charge, the latter being the
product of the cost of capital and the economic capital. The basic formula is:
, is the Return on Invested Capital (ROIC);
is the weighted average cost of capital (WACC);
is the economic capital employed;
NOPAT is the net operating profit after tax, with adjustments and translations, generally for the
amortization of goodwill, the capitalization of brand advertising and others non-cash items.
EVA = net operating profit after taxes – a capital charge [the residual income method]
therefore EVA = NOPAT – (c × capital), or alternatively
EVA = (r x capital) – (c × capital) so that
EVA = (r-c) × capital [the spread method, or excess return method]
r = rate of return, and
c = cost of capital, or the Weighted Average Cost of Capital
NOPAT is profits derived from a company’s operations after cash taxes but before financing
costs and non-cash bookkeeping entries. It is the total pool of profits available to provide a cash
return to those who provide capital to the firm.
Capital is the amount of cash invested in the business, net of depreciation. It can be calculated as
the sum of interest-bearing debt and equity or as the sum of net assets less non-interest-bearing
current liabilities (NIBCLs).
The capital charge is the cash flow required to compensate investors for the riskiness of the
business given the amount of economic capital invested.
The cost of capital is the minimum rate of return on capital required to compensate investors
(debt and equity) for bearing risk, their opportunity cost.
Another perspective on EVA can be gained by looking at a firm’s return on net assets (RONA).
RONA is a ratio that is calculated by dividing a firm’s NOPAT by the amount of capital it
employs (RONA = NOPAT/Capital) after making the necessary adjustments of the data reported
by a conventional financial accounting system.
EVA = (RONA – required minimum return) × net investments
If RONA is above the threshold rate, EVA is positive.
Comparison with other approaches
Other approaches along similar lines include Residual Income Valuation (RI) and residual cash
flow. Although EVA is similar to residual income, under some definitions there may be minor
technical differences between EVA and RI (for example, adjustments that might be made to
NOPAT before it is suitable for the formula below). Residual cash flow is another, much older
term for economic profit. In all three cases, money cost of capital refers to the amount of money
rather than the proportional cost (% cost of capital); at the same time, the adjustments to NOPAT
are unique to EVA.
Although in concept, these approaches are in a sense nothing more than the traditional,
commonsense idea of "profit", the utility of having a separate and more precisely defined term
such as EVA is that it makes a clear separation from dubious accounting adjustments that have
enabled businesses such as Enron to report profits while actually approaching insolvency.
Other measures of shareholder value include:
Market value added
Total shareholder return.
Relationship to market value added
The firm's market value added, or MVA, is the discounted sum (present value) of all future
expected economic value added:
Note that MVA = PV of EVA.
More enlightening is that since MVA = NPV of Free cash flow (FCF) it follows therefore that
NPV of FCF = PV of EVA;
since after all, EVA is simply the re-arrangement of the FCF formula.
Integrating EVA and PBC
Recently, Mocciaro Li Destri, Picone & Minà (2012)
proposed a performance and cost
measurement system that integrates the EVA criteria with Process Based Costing (PBC). The
EVA-PBC methodology allows us to implement the EVA management logic not only at the firm
level, but also at lower levels of the organization. EVA-PBC methodology plays an interesting
role in bringing strategy back into financial performance measures.
What is the difference between economic
value added and market value added?
Economic value added (EVA) is a performance measure developed by Stern Stewart & Co that
attempts to measure the true economic profit produced by a company. It is frequently also
referred to as "economic profit", and provides a measurement of a company's economic success
(or failure) over a period of time. Such a metric is useful for investors who wish to determine
how well a company has produced value for its investors, and it can be compared against the
company's peers for a quick analysis of how well the company is operating in its industry.
Economic profit can be calculated by taking a company's net after-tax operating profit and
subtracting from it the product of the company's invested capital multiplied by its percentage
cost of capital. For example, if a fictional firm, Cory's Tequila Company (CTC), has 2005 net
after-tax operating profits of $200,000 and invested capital of $2 million at an average cost of
8.5%, then CTC's economic profit would be computed as $200,000 - ($2 million x 8.5%) =
$30,000. This $30,000 represents an amount equal to 1.5% of CTC's invested capital, providing a
standardized measure for the wealth the company generated over and above its cost of capital
during the year.
Market value added (MVA), on the other hand, is simply the difference between the current total
market value of a company and the capital contributed by investors (including both shareholders
and bondholders). MVA is not a performance metric like EVA, but instead is a wealth metric,
measuring the level of value a company has accumulated over time. As a company performs well
over time, it will retain earnings. This will improve the book value of the company's shares, and
investors will likely bid up the prices of those shares in expectation of future earnings, causing
the company's market value to rise. As this occurs, the difference between the company's market
value and the capital contributed by investors (its MVA) represents the excess price tag the
market assigns to the company as a result of it past operating successes.