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ISSN 2249-877X
Pu b l i s h ed b y : S o u th As i a n Aca d e m i c Re s ea r ch J o u rn a l s
SAJMMR:
South Asian Journal of Marketing & Management Research ECONOMIC VALUE ADDED PERFORMANCE A CASE STUDY IN HINDUSTAN UNILEVER LTD.
DR. (MRS.) S. KALAISELVI* *Assistant Professor & Head, PG Department of Commerce with Computer Applications, Vellalar College for Women, Erode-12. ABSTRACT Economic Value Added is the financial performance measure that comes closer than any other to capture the true economic profit of an enterprise. EVA is the performance measure most directly linked to the creation of shareholder wealth over time. EVA-based financial management and incentive compensation system, gives managers superior information and superior motivation to make decisions, that will create the greatest shareholder wealth in any publicity owned or private enterprise. Stern Stewart & Co., is a Global consulting firm, which was established in 1982, developed EVA. Economic Value Added is currently a very popular idea. This has led to restructuring, lowering of cost of capital, efficiency improvement and dramatic increase in current market value. EVA is essentially the surplus left after making an appropriate change for the capital employed in the business. The analysis of Economic Value Added (EVA) of Hindustan Unilever Limited helps in maximizing the wealth of shareholders effectively. ___________________________________________________________________________ INTRODUCTION Economic Value Added is the financial performance measure that comes closer than any other to capture the true economic profit of an enterprise. EVA is the performance measure most directly linked to the creation of shareholder wealth over time. EVA-based financial management and incentive compensation system, gives managers superior information and superior motivation to make decisions, that will create the greatest shareholder wealth in any publicity owned or private
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ISSN 2249-877X
enterprise. Stern Stewart & Co., is a Global consulting firm, which was established in 1982, developed EVA. EVA CONCEPT EVA is Net Operating Profit minus an appropriate change for the opportunity cost of all capital invested in an enterprise. As such, EVA is an estimate of true economic profit or, the amount by which earnings exceed or fall short of the required minimum rate of return that shareholders and lenders could get by investing in securities of comparable risk. The EVA institute is the continuing education forum exclusively for Stern Stewart EVA clients. Stern Stewart formed the institute out of its commitment to continuous improvement and helping client companies achieve the very best result possible with the EVA financial management and incentive compensation systems. EVA is A value-based financial performance measure.
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A measure reflecting the absolute amount of shareholder value created or destroyed during each year. A useful tool for choosing the most promising financial investments. An effective protection against shareholder value destruction. A tool suitable to control operations. A measure highly correlated with stock prices. A good basis for management compensation system to motivate managers to create shareholder value. A tool more useful than Rate of Return (ROI) in controlling and steering day-to-day operations. A concept practically the same as Economic Profit (EP), Residual Income (RI) and Economic Value Management (EVM). TRADITIONAL MEASURES FOR FINANCIAL PERFORMANCE The important traditional measures for financial performance are, Net Interest Margin (NIM) Return On Assets (ROA) Return On Equity (ROE) South Asian Academic Research Journals http://www.saarj.com
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Earnings Per Share (EPS) NET INTEREST MARGIN (NIM) Net Interest Margin is defined as ratio of interest spread and average total assets. Interest spread is the difference between interest earned and interest expended. The NIM measures the core earning capacity of the company and is an indicator of the efficiency of the overall portfolio management. RETURN ON ASSETS (ROA) Return on Asset is the ratio of net profit (operating profit minus all provisions) to total assets. It indicates the ability of the management to convert the assets of the company into net earnings and also indicate the amount of net income generated per rupee of investment in the firms assets. RETURN ON EQUITY (ROE)
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Return on Equity is a measure of performance and a Yardstick for shareholders value, based on book values of networth and Net profit. EARNINGS PER SHARE (EPS) Earnings Per Share represents earning available to each common share and is an important element to judge an appropriate market price of a share. Over the past several years, the EVA measure has been gaining acceptance all over the world. It has been acknowledged by institutional firms as a creditable performance measure. It encourages the companies to enter product-markets that can boost their sales consequently and to evaluate options to choose the strategy for maximizing the shareholders value. It is the value of a company to which investors expect future profits or fall short of the cost of capital. COMPONENTS OF EVA Although EVA is an accounting-based measure, it differs from conventional earningsmeasurements in two important ways: Conventional accounting profit (net income) is adjusted to reflect the current economics of business. To compensate shareholders for the risk-prone of their equity investment in the company, a charge for all debt and equity is subtracted from Net Operating Profit Less Adjusted Taxes (NOPLAT).
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NET OPERATING PROFIT LESS ADJUSTED TAXES Net Operating Profit Less Adjusted Taxes represents the total pool of profits available to provide a cash return to all financial contributors of capital (equity as well as debt) to the company. NOPLAT is the operating profits of the firm. INVESTED CAPITAL Invested Capital represents the total amount of capital invested in the operations of a company over its life without regard to the source of financing the capital. RETURN ON INVESTED CAPITAL The EVA of a company is just a measure of the increment return its investment earns over the market rate of return. Companies fund their investments from equity, debt or retained earnings. The returns equity investors expect from a company are, at the very least, equal to what they will achieve by investing in the market index although the actual figure depends on the risk profile of the company. The return institutional and private lenders expect from a company are, again, at the very least, equal to prime lending rate. Even retained earnings, contrary to what most managers believe, are not totally free. The company can, after expect some returns from its retained earnings if it invest them in either the equity or debt markets. The ROIC represents the total percentage return the company generated on its average invested capital. ROIC= (NOPLAT/ Average Invested Capital)*100 WEIGHTED AVERAGE COST OF CAPITAL (WACC) Weighted average cost of capital is an opportunity cost that is equivalent to the rate of return investor could expect to earn by investing in stock of other companies of comparable risk. A company should explore projects that provide a ROIC that is greater than WACC to add wealth to its capital position, which can be distributed to its investors. Similarly companies should reject the projects that provide an ROIC that is less than WACC. The WACC is essentially the weighted average of the cost of debt and the cost of equity. IMPLEMENTING EVA The companies do not use EVA, but implement it. Implementing EVA is a four-step process. Stern-Stewart calls this the 4M processes. The 4Ms are Measurement Management System Motivation
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Mindset MEASUREMENT
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Any company that wishes to implement EVA should institutionalize the process of measuring the metric regularly. This measurement should be carried out after carrying out the accounting adjustments. MANAGEMENT SYSTEM To implement EVA the company should be wiling to align its management system to the EVA process. The EVA management System is the basis on which the company should take decisions related to the choice of strategy, capital allocation, divesting business and goal-setting MOTIVATION
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Companies should decide to implement EVA only if they are prepared to implement the incentive plan that goes with it. This plan ensures that the managers can earn higher bonus by creating more value for shareholders. EVA- based incentive system, encourages managers to operate in such a way as to maximize the Eva, not just of the operation they oversee, but of the company as a whole. Thus, its aim is to make every employee of an organization an entrepreneur, who seeks out just to perform his or her function well. MINDSET The effective implementation of EVA necessitates a change in the culture and Mindset of the company. Indeed, EVA is an ideal tool to bring about a transformation in a companys culture. Its singular focus leaves no room for ambiguity. It is not difficult for employees to know just which action by them will create EVA and which will destroy it. BENEFITS OF EVA The real purpose of EVA is to serve as the centerpiece of an integrated management and compensation system, which helps in creation of lasting shareholders value. Some of the benefits of EVA are It creates greater accountability among employee. It institutes a common frame work in the organization. It creates greater willingness to optimize resources. It increases productivity through incentives. It lines corporate strategy to financial results. South Asian Academic Research Journals http://www.saarj.com
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It leads to an EVA-driven cultural transformation. EVA FRAMEWORK EVA = (Return On Invested Capital Weighted Average Cost of Capital) x Invested Capital Return On Invested Capital = (NOPLAT/ Average Invested Capital) x 100 NOPLAT = Net Operating Profit Less Adjusted Tax Invested Capital = Total amount of capital invested in the operations of a bank Weighted Average Cost of Capital (WACC) = K eW e + KdWd Where,
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Ke = Cost of Equity =
D iv 1 P0
D iv 1 P0
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DIV1 = Dividend Per Share Po = Market Price Per Share g = b * ROE Net Profit After Tax ROE = Market Value of Equity Market Value of Equity We = Total Value of Debt & Equity We = Equity Ratio INT South Asian Academic Research Journals http://www.saarj.com
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Kd = Market Value of Debt Kd = Cost of Debt INT = Interest Expenses Market Value of Debt Wd = Total Value of Debt & Equity Wd = Debt Ratio RESULTS AND DISCUSSION (TABLE 1.1 THROUGH 1.5)
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Hindustan Unilever Limiteds Economic Value Added performance had been eloquently shown in the table 1.5.The Return On Investment capital varied between 30.51% and 64.32% during the study period. (Table 1.3) Weighted Average cost of capital increased from 15.15% during 2006-07 to 19.26% during 2010-11. EVA was Rs.162150.37 crores during 2006-07 and there was a slight increase to Rs.170122.48 crores during 2007-08. EVA registered during 2010-11 was Rs.114147.48. Economic Value Added performance of Hindustan Unilever Limited shows a positive position towards an effective management. It implies that the Economic Value Added should be increased in future periods.It is suggested that the Weighted Average Cost of Capital has to be reduced and Return on Investment Capital should be increased. This will further result in aspect in the EVA performance of the company. Financial health of HUL can be improved to maximize the Wealth of the Stakeholders. CONCLUSION Economic Value Added as a measure of total factor productivity. Peter F.Drucker.
Economic Value Added is currently a very popular idea. This has led to restructuring, lowering of cost of capital, efficiency improvement and dramatic increase in current market value. EVA is essentially the surplus left after making an appropriate change for the capital employed in the business. The analysis of Economic Value Added (EVA) of Hindustan Unilever Limited helps in maximizing the wealth of shareholders effectively.
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ISSN 2249-877X
NET OPERATING PROFIT LESS ADJUSTED TAX (NOPLAT) (RS. IN CRORES) S. No 1 PARTICULARS Total Income 20062007 12813.81 20072008 14112.71 20082009 20630.88 20092010 16950.71 20102011 20154.22
2
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Operating Expenses
10438.33
11604.13
17355.33
13971.42
17025.42
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2508.58
3275.55
2979.29
3128.80
331.74
426.36
587.56
657.20
588.99
NOPLAT (3)-(4)
2043.74
2082.22
2687.99
2322.09
2539.81
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2006-2007
2007-2008
2008-2009
2009-2010
2010-2011
Operating Current Assets: A] Cash & Bank Balances B] Inventories C]Sundry Debtors D] Loans & Advances 416.94 1547.71 440.37 764.63 200.86 1953.59 443.37 679.58 1777.35 2580.53 536.89 757.86 1892.21 2179.93 678.44 617.18 1787.26 2811.26 943.20 663.22
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3169.65 Other Liabilities Operating working capital [12] Fixed Assets Other Operating Assets: A] Advances 764.63 679.58 2732.72 436.93 2462.69
2 3 4 5
757.86
617.18
663.22
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B] Reserves C] Debts
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1511.84
2150.04
3005.46
2765.35
608.55
1928.44
875.80
86.35
8 9
3297.75 0.00
5027.26 0.00
7979.34 0.00
7242.00 0.00
7416.99 0.00
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2006-2007 3297.75
2007-2008 5027.26
2008-2009 7979.34
2009-2010 7242.00
2010-2011 7416.99
Source: Annual Reports of Hindustan Unilever Limited. TABLE 1.3 RETURN ON INVESTED CAPITAL (ROIC)
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(RS. IN CRORES) S. No 1 Particulars Net Operating Profit Less Adjusted Tax (NOPLAT) Average Invested Capital 2 (Current year + Previous year /2) 3 ROIC [1/2 * 100] 64.32% 50.02% 41.33% 30.51% 34.65% 3177.32 4162.51 6503.30 7610.67 7329.50 2006-2007 2043.74 2007-2008 2082.22 2008-2009 2687.99 2009-2010 2322.09 2010-2011 2539.81
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Particulars Value of Equity Value of Debt Total Value [1+2] Equity Ratio [1/3] Debt Ratio [2/3] Dividend Payout Ratio (%) Retention Ratio [1-6] (%) Return on Equity (ROE) (%) Growth Rate (g) [7*8] (%) Dividend Per Share Growth in dividend [10*9]+10 Current Market Price Per Share (po) Dividend Yield [11/12] Cost of Equity (ke) [13+9] (%) Interest Expenses Cost of debt (kd) [15/2] (%) Equity Ratio (Shareholders fund/Total
2006-2007 220.68 56.94 277.62 0.80 0.20 78.40% 21.60% 84.36 18.22 7.57 145.49 218.00 0.67 18.89 10.73 0.19 15.11
2007-2008 217.75 72.60 290.35 0.75 0.25 79.39% 20.61% 100.32 20.68 7.89 171.06 223.00 0.77 21.45 25.50 0.35 16.09
2008-2009 217.99 88.53 306.52 0.71 0.29 80.22% 19.78% 138.66 27.43 8.14 231.42 241.00 0.96 28.39 25.32 0.29 20.16
2009-2010 218.17 421.94 640.11 0.34 0.66 80.79% 19.21% 124.08 23.84 9.00 223.56 242.00 0.92 24.76 26.98 0.06 8.42
2010-2011 215.95 56.00 271.95 0.79 0.21 81.45% 18.55% 126.43 23.45 9.00 220.05 267.45 0.822 24.27 24.89 0.44 19.17
3 4 5 6 7 8 9 10 11 12 13 14 15 16 17
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Assets) [14*4] (%) 18 19 Debt Ratio [16*5] (%) WACC [17+18] 0.04 15.15 0.09 16.18 0.08 20.24 0.04 8.46 0.09 19.26
Source: Annual Reports of Hindustan Unilever Limited. TABLE 1.5 ECONOMIC VALUE ADDED PERFORMANCE ANALYSIS
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(RS. IN CRORES) S. No 1 2 3 4 5 Particulars Return on Invested Capital (ROIC) (%) Weighted Average Cost of Capital (WACC) (%) ROIC-WACC [1-2] (%) Invested Capital EVA [3*4] 2006-2007 64.32% 15.15% 49.17% 3297.75 162150.37 2007-2008 50.02% 16.18% 33.84% 5027.26 170122.48 2008-2009 41.33% 20.24% 21.09% 7979.34 168284.28 2009-2010 30.51% 8.46% 22.05% 7242.00 159686.10 2010-2011 34.65% 19.26% 15.39% 7416.99 114147.48
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