Eva22

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EVA PRESENTATION

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  • Point out that economics is a study of allocating scarce resources. Farmers are very accustomed to thinking about resources such as land, labor, and capital (which includes production inputs). But they may not consider time fully as they make decisions about some enterprises, including value-added options. It is important here to emphasize the time requirement.
  • Eva22

    1. 1. <ul><li>Under the guidence of </li></ul><ul><li>Mr. SACHIN VERMA </li></ul>PRESENTATION ON (EVA,MVA,CAPM)
    2. 2. Introduction of EVA <ul><li>EVA was developed by a New York consulting firm, Stern Steward & Co. in 1982 to promote value-maximisig behaviour in corporate managers. </li></ul><ul><li>Value-based measure to evaluate business strategies, capital projects and to maximise long-term shareholders wealth. </li></ul><ul><li>EVA sets managerial performance target and links it to reward systems. </li></ul><ul><li>Unlike simple traditional budgeting. EVA focuses on ends and not means. </li></ul>
    3. 3. A Definition… <ul><li>Economics: The study of how scarce resources are allocated among competing ends </li></ul>Land Labor Capital Time
    4. 4. Definition for EVA <ul><li>EVA is defined as net profit after taxes and after the cost of capital. </li></ul><ul><li>FORMUALE for EVA </li></ul>EVA Net operating profit Taxes Cost of capital
    5. 5. An Integrated Measure of Business Performance <ul><li>Sales </li></ul><ul><li>Cost of Sales </li></ul><ul><li>Overhead </li></ul><ul><li>EBIT </li></ul><ul><li>Tax on Operations </li></ul><ul><li>NOPAT </li></ul>EVA = Operating Profit - Opportunity Cost of Running the Business The return (or expectation) foregone by not investing in a comparably risky portfolio of projects—the weighted cost of debt and equity capital. Opp. Cost = Cost of Capital x Beg. Capital Cost of Borrowing? Dividend Yield?
    6. 6. An Integrated Measure of Business Performance EVA = NOPAT - c* x Beg. Capital <ul><li>EVA introduces four powerful incentives: </li></ul><ul><li>Improve efficiency, and thus returns. </li></ul><ul><li>Grow, but only if new investments can earn the cost of capital. </li></ul><ul><li>Redeploy capital from underperforming operations. </li></ul><ul><li>Manage risk, and therefore the cost of capital. </li></ul>EVA can also be expressed as: EVA = (Return on Capital - Cost of Capital) x Beg. Capital
    7. 7. EVA Implementation Process Understand and appreciate current readiness for change Determine strategy (objectives, messages, and media) Develop training/ communication materials Rollout Evaluate Results Step 1 Step 2 Step 3 Step 4 Step 5
    8. 8. Framework Example: A Major Oil & Gas Company Operating Profit Gasoline Operating Profit Distillate Operating Profit Car Wash Operating Profit Convenience Store Oper. Profit Lubricants Operating Profit Gasoline Operating Profit
    9. 9. Calculating (NOPAT) <ul><li>NOPAT is easy to calculate. From the income statement we take the operating incomes and subtract taxes. </li></ul><ul><li>e.g. XYZ Company </li></ul>Particulars Amount (Rs.) Sales 24,36,000/- Cost of Goods sold (-) 17,00,000/- Gross Profit 7,36,000/- Selling, general & Admin Exp. (-) 4,00,000/- Operating Profit 3,36,000/- Taxes (-) 1,34,000/- NOPAT 2,02,000/-
    10. 10. Cost of Capital <ul><li>Meaning: </li></ul><ul><li>The cost of capital is the rate of return required by the shareholders and lenders to finance the operations of the business. </li></ul><ul><li>Types of Cost of Capital:- </li></ul><ul><li>Equity Capital: Equity Capital is provided by the Shareholders. </li></ul><ul><li>Borrowed Capital: It is the Capital borrowed by the company from Banks and other Financial Institutes. </li></ul>
    11. 11. Weighted Average Cost of Capital (WACC) <ul><li>Weighted Average Cost of Capital examines the various components of the Capital structure and applies the weighting factor of after-tax cost to determine the cost of Capital. </li></ul><ul><li>Calculating WACC </li></ul><ul><li>e.g. XYZ Company </li></ul>Particulars Amount (Rs.) Long Term Debt 5,00,000/- Preferred Stockholders Equity 2,00,000/- Total Common Equity 7,00,000/- Total Capital 14,00,000/-
    12. 12. Calculation of WACC for XYZ Company The total Weighted Average Cost of Capital (WACC) = 1,68,478 / 14,00,000 = 12.03% Particulars Amount (Rs.) Cost (%) Total (Rs.) Long Term Debt 5,00,000/- 9.47 47,375/- Preferred Stock Cost 2,00,000/- 11.2 22,400/- Common Equity Cost 7,00,000/- 14.1 98,700/- Total Capital 14,00,000/- - 1,68,475/-
    13. 13. Calculation of EVA for XYZ Company NOPAT Rs. 2,02,000/- Capital Employed (Including Rs.1,00,000/- Reserve & Surplus) Rs. 15,00,000/- Cost of Capital 12.03% Capital Charge (12.03/100 x Rs. 15,00,000/-) Rs. 1,80,450/- Economic Value Added (EVA) (Rs. 2,02,000 – Rs. 1,80,450) Rs. 21,550/-
    14. 14. Strategies for Increasing EVA <ul><li>Increase the return on existing projects (improve operating performance). </li></ul><ul><li>Invest in new projects that have a return greater than the cost of capital. </li></ul><ul><li>Use less capital to achieve the same return. </li></ul><ul><li>Reduce the cost of capital. </li></ul><ul><li>Liquidate capital or curtail further investment in sub-standard operations where inadequate returns are being earned. </li></ul>
    15. 15. Advantages of EVA <ul><li>EVA provides for better assessment of decisions that affect balance sheet and income statement or tradeoffs between each through the use of the capital charge against NOPAT. </li></ul><ul><li>EVA decouples bonus plans from budgetary targets. </li></ul><ul><li>EVA covers all aspects of the business cycle. </li></ul><ul><li>EVA aligns and speeds decision making, and enhances communication and teamwork. </li></ul>
    16. 16. Limitations of EVA <ul><li>EVA does not control for size differences across plants or divisions. </li></ul><ul><li>EVA is based on financial accounting methods that can be manipulated by managers . </li></ul><ul><li>EVA may focus on immediate results which diminishes innovation. </li></ul><ul><li>EVA provides information that is obvious but offers no solutions in much the same way as historical financial statement do. </li></ul>
    17. 17. Conclusion As a performance measure, Economic Value Added forces the organization to make the creation of shareholder value the number one priority. EVA is changing the way managers run their businesses. When business decisions are aligned with the interest of the shareholders, it is only a matter of time before these efforts are reflected in a higher stock price.
    18. 18. MVA (MARKET VALUE ADDED) <ul><li>Market Value Added (MVA) is a measure of wealth a company has created for its investors. </li></ul><ul><li>It is a cumulative measure of corporate performance that looks at how much a company’s stock has added to (or taken out of) investors’ pocketbooks over its life and compares it with the capital those same investors put into the firm. Maximizing MVA should be the primary objective for any company that is concerned about its shareholders’ welfare. </li></ul>
    19. 19. Measuring Corporate Success: The Ultimate Financial Test <ul><li>A high stock price? </li></ul><ul><li>Market capitalization? </li></ul><ul><li>Rapid stock price appreciation? </li></ul><ul><li>A large and growing market premium to book value? </li></ul>MVA ! Total Market Value Cost of Invested Capital
    20. 20. <ul><li>Market Value Added (MVA) is the difference between the current market value of a firm and the capital contributed by investors . </li></ul><ul><li>If MVA is positive, the firm has added value. If it is negative, the firm has destroyed value. </li></ul><ul><li>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 of the firm relative to the market. </li></ul>
    21. 21. The formula for MVA is: <ul><li>where : </li></ul><ul><li>MVA is market value added </li></ul><ul><li>V is the market value of the firm, including the value of the firm's equity and debt </li></ul><ul><li>K is the capital invested in the firm </li></ul>
    22. 22. IMPORTANCE OF MVA <ul><li>In this paper the authors give some detail on how the numbers in an EVA and MVA calculation are actually determined. They also demonstrate that the EVA and MVA measures of financial performance can effectively be used in managing a company’s operations, in guiding its strategies and in providing incentives to its employees. </li></ul>
    23. 23. MVA Calculation. <ul><li>First, all the capital a company took in over its span of existence is added up. This includes equity and debt offerings, bank loans, and retained earnings. Then some adjustments are made that capitalize certain past expenditures, like R&D spending, as an investment in future earnings. This adjusted capital amount is compared to a firm’s total market value, which is the current value of a company’s stock and debt to get MVA or the difference between what the investors can take out and the amount investors put in. </li></ul>
    24. 24. FORMULA FOR MVA <ul><li>MVA = [(Shares outstanding x Stock price) + Market value of preferred stock + Market value of debt] – Total capital </li></ul>
    25. 25. CAPM <ul><li>What Does Capital Asset Pricing Model - CAPM Mean? A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. </li></ul>
    26. 26. <ul><li>The capital asset pricing model (CAPM) is used in finance to determine a theoretically appropriate required rate of return (and thus the price if expected cash flows can be estimated) of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk. </li></ul><ul><li>The CAPM formula takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk </li></ul>
    27. 27. Assumptions of CAPM: <ul><li>- All investors have rational expectations. -All investors are risk averse. -There are no arbitrage opportunities. -Returns are distributed normally. -Fixed quantity of assets. -Perfect capital markets. -Separation of financial and production sectors. -Thus, production plans are fixed. -Risk-free rates exist with limitless borrowing capacity and universal access.. </li></ul>
    28. 28. THANK YOU FOR YOUR KEEN INTEREST <ul><li>Presented by: </li></ul><ul><li>Hemant Kumar </li></ul><ul><li>MBA II Sem. </li></ul>

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