Project Tittle“A STUDY OF ECONOMIC VALUE ADDED (EVA)AND ITS RELATIONSHIP WITH THE SHARE PRICE”Internal Guide :- Prepared By:-Suman Rajesh T.D Praveen Kumar H.PAsst.Prof, MBA 4th Sem, MBAP.E.S.C.E, Mandya P.E.S.C.E, Mandya
Definition of ‘Economic Value Added’(EVA) &Share Pricea) A measure of a companys financial performance based on the residual wealthcalculated by deducting cost of capital from its operating profit (adjusted for taxes on acash basis). (Also referred to as "economic profit".)The formula for calculating EVA is as follows:= Net Operating Profit After Taxes (NOPAT) - (Capital * Cost of Capital)This measure was devised by Stern Stewart & Co. Economic value added attempts tocapture the true economic profit of a company.b) The price of one share of stock is Share price.
Executive Summary of the Project• Eva Produce a more economically meaningful version of residual income.• Attempt- To analyze the EVA with that of Market price to see whether, EVA is the maindriver for shareholder value or not.• The project is conducted in order to exhibit the relationship between stock return andeconomic value added (EVA) as compare to the relationship with other variable such as netincome (NI) and operating cash flow (OCF) with in BSE stock Market.• It is evident from the study that the contribution of Operating cash flow is higher ascompare to EVA and NI which is a prediction of the least contribution of the EVA in stockreturn as shown by the individual regression analysis of these variables with stock return.• Finally EVA is negatively contributing to the stock return as compare to the other variableshown both by regression.• One of the major benefits of using EVA as a decision tool is in the area of assetmanagement, allocation of resources and capital structure including the operating leverage.Furthermore, EVA is appealing to developing companies that need to fund their projectsthrough satisfying the value of enhancement requirements of investors. The objective ofthis approach to capital allocation is to ensure that the line of business is constantlycontributing to the improvement of the return on existing capital, seeking investment thatcreate value to shareholders and maintaining optimal capital structure levels.
Rational for the chosen Topic & Statement of theProblem.• The management decision-making process involves mainly the evaluation ofinvestment and the allocation of the companys resources. The traditional process inmaking such decisions is based on cash flow and it is referred to as capital budgeting.EVA may be added now as an additional tool in making investment decisions thatinvolves new projects, mergers and acquisitions. In this respect, EVA is close to netpresent value (NPV) technique. This would provide a new dimension for managersto maximize wealth for the shareholders.• The development in the Indian capital market along with the increased awarenessamong the shareholders has increased the pressure on the companies to consistentlyperform better. Investors are very much keen in knowing what amount of wealth thecompany has created for the shareholders. So, the value created by the company ismore linked to the market price of the shares. So, the question that has to beaddressed here is that whether the value addition by the company is also adependent factor for the movement in the share price. Hence, there was a need tofind out the relationship between the value added by the company and share price.Hence this study entitled “A study of Economic value added (EVA) and itsrelationship with the share price” was carried out.
Objectives of the study• The objectives of this study were as follows:• To ascertain EVA for sample companies.• To analyze the relationship between EVA and share price.Evidences from India• In India the concept of EVA is still in its evolving stage. Very few companies have adopted thistechnique. Infosys had added Rs. 20 crores in FY98. Dr. Reddy’s Laboratories hadexperienced a growth of its value to Rs. 14.5 crore in FY98 which was negative figureof –Rs. 3.5 crore before introducing EVA in FY97.
Sample Size:- 10stocks, which are constituents ofBSE SENSEX.• BHEl- Engineering & Manufacturing Enterprise• BP - Crude oil• ITC- FMGC Products• GAIL- Natural gas pipeline projects• TATA POWER- Power generation• TATA STEEL- Steel producing company• HERO MOTORS- Motorcycle Manufacturing• HINDALCO INDUSTRIES- Aluminum Manufacturing• L & T- Engineering, construction, Manufacturing, IT,Financial services, Power,• GRASIM INDUSTRIES- Synthetic fabrics
Project Design• Descriptive Research- The idea behind this type of research is to studyfrequencies, averages, and other statistical calculations. Although this research ishighly accurate, it does not gather the causes behind a situation. Descriptive researchis mainly done when a researcher wants to gain a better understanding of a topic.• Analytical Research-Analytical means the researcher use facts and informationalready available and the analysis and making the evaluation.• Secondary Data.Limitations of the Project• The Project is a limited time span of 1 to 2 year.• The Project includes selected stock listed in BSE Stock market.• The study is undertaken for only 8 Years period only.
Data Analysis Techniques• Simple Regressions:-Generally, Regression expresses the relationship among variables which helpful inestimating and predicting the average value of one variable for a given value of the othervariable and in the case of linear regression, a dependent variable y in a regression modeltends to increase in direct proportion to an increase in the values of independentvariables. following data were taken.• Capital employed, Earnings per share, Net income of the company, ROCE, RONWTrend Analysis:-• Forecasting technique that relies primarily on historical time series data to predict thefuture. The analysis involves searching for a right trend equation that will suitablydescribe trend of the data series. The trend may be linear, or it may not. A lineartrend can be obtained by using a least squares method . The line has theequation y = a + bt where t = 1,2,3 . . ., b = slope of the line, and a = value of y when t =0. The coefficients of the equation, a and b, can be determined using these equations.
Overall Observation From Data AnalysisFrom the data analysis, It is clear that EVA will rise if operating efficiency is improved, If valueadding investments are made, If uneconomic activities are curtailed, and If the cost of capital islowered. In more specific terms, EVA rises when,• The rate of return on existing capital increases because of improvement in operatingperformance. This means that the operating profit increases without infusion of additioncapital in the business.• Additional capital is invested in projects that earn a rate of return greater than the cost ofcapital.• Stopping the activities which earns inadequate returns.• Lowering the cost of capital by altering the financing strategy.The share price of the companies are showing increasing trend irrespective of the trend in EVA.Even the companies which are having negative EVA are showing an increasing trend in theshare price. This shows that movement of share price in Indian stocks is not influenced by theEVA. In order to conduct deep analysis and to find out further empirical evidence regressiontests have conducted. This test will also reveal the other factors that influence the share price.
Observation From RegressionAnalysisAll the predictors(Constant) i.e., EVA, ROCE, RONW, EPS and profit influence the shareprice(Dependent variable) to the some extent.It is evident that influence of EVA on share is less; in fact it is All (2005-2012) yearsnegative. This is not possible in the real life situation. A value of the firm cannot beinversely influence the share price. Hence, it can be concluded that EVA has no influenceon the share.• 2005 - among other determinants RONW influence the share price the most. It showsthe highest T-value among all others. Hence, the test infers that in the year2005, RONW is the most determining factor of share price than EVA and otherfactors.• 2006 – RONW• 2007 – EPS• 2008 – EPS• 2009 – EPS• 2010 – EPS• 2011 – EPS• 2012 – EPS
Suggestions• For Company:A company has to follow the wealth maximization principle in order to have goodcorporate governance. The company has to direct all the activities towards maximizingshare holders value. A company can increase its shareholders’ value in the followingways (this is the outcome of the analysis of objective 1):• The rate of return on existing capital increases because of improvement in operatingperformance. This means that the operating profit increases without infusion ofaddition capital in the business.• Additional capital is invested in projects that earn a rate of return greater than thecost of capital. It also means that investments with positive NPV only should beaccepted.• From the existing business unprofitable assets has to be sold, so as to give a greaterreturn than the capital charge.• Lowering the cost of capital by altering the financing strategy.For investors:• The investors who are thinking of investing on the share with long term orientationthen they must invest in the company which has been proving consistently to bevalue creators. This will ensure the capital appreciation of the investment done by thecompany.
Conclusion• Objective 1: To ascertain EVA for sample companies.From the analysis of the EVA of the company it can be concluded that the value driverswhich is responsible for the value creation and value erosion of the company are operatingprofits, Cost of capital and return on new investments made. Hence, the company shouldfocus on redesigning the capital structure in order to reduce the capital cost and invest ononly those investments which will earn more returns.• Objective 2: To analyze the relationship between EVA and stock price.From the study it can be concluded that the relationship between the EVA and share priceis not significant. There is a negative relationship between the share price and EVA insome occasion, which is an unrealistic outcome. In real life situation there can be negativerelationship between the share price and EVA of the company. Hence, we can say that theEVA does not influence share price significantly. But when we considered otherdetermining factors such as EPS, ROCE, RONW and profit of the company, EPS turned outto be a major determining factor of share price. Hence, we can conclude that Earning perShare is a major influencing factor of the share price among EVA, ROCE, RONW andProfit of the company.
Bibliography• Anastasias, Christos & Dimitris “Validity of the Economic Value Added Approach:An Empirical Application”, European Financial Management, Vol 13, pp 71-100• Dr. Raman, D.V. (2007), “MVA and EVA: Some empirical evidence”, Journal ofFinance,, Vol 11, pp 23-41• Dr. Karam Pal and Sura, Jasvir S. (2007)“Economic Value Added and TraditionalPerformance Measures”, Amity Journal of business Strategy, Vol.1(2), June 2007, pp110-120• Garvey, T. Gerald and Milbourn, Todd T,(2000), “EVA versus Earnings: Does ItMatter Which is More Highly Correlated with Stock Returns?”, Journal of accountingresearch, Vol 38.• Ferguson, Robert, Rentzler, Joel, and Susana Yu (2005) “Does Economic Value Added(EVA) Improve Stock Performance Profitability?”, Journal of applied finance, Vol 23.• Griffith, John M (2006), “EVA and Stock Performance”, Journal of Investing, Vol 12.• Biddle, C. Gary, Bowen, M. Robert and Wallace, S. James (1998),“Economic ValueAdded: Some Empirical Evidence”, Managerial Finance, Vol 24, pp 60-71.• Brewer, C. Peter, “Economic Value added: its uses and limitation”, SAMAdvancement management Journal, 1999, Vol 19, pp 21-29.Websites• www.investopedia.com• www.capitaline.com• www.valuebasedmanagement.net• www.evanomics.com• www.rbi.org.in• www.bseindia.com• www.indiainfoline.com