CORPORATE PERFORMANCE MEASUREMENT

THROUGH EVA

Dr. Vishal Kumar

Assistant Professor in Commerce
Dev Samaj College for Women
Ferozepur City (PB)
Abstract: Economic alue A!!e! (EA) is a value "ase! performance
measure t#at gives importance on value creation "y t#e management for
t#e o$ners% Pro&t ma'imization as a concept is age(ol!) $ealt# ma'imization
is mature! an! value ma'imization is to!ay*s $is!om% Stern Ste$art*s EA
raises storm in corporate $orl! an! gives a ne$ $ay to t#in+ a"out
re$ar!ing management% ,sa"ility of EA largely !epen!s on t#e -uality of
accounting information system) as tra!itional information system $ill not
provi!e su.cient information to compute true EA% /#us) EA is re-uire! to
"e tailore! in line $it# accounting system) management p#ilosop#y an! t#e
!egree of !eman! of suc# a system% 0n t#is paper) an earnest e1ort #as "een
ma!e to e'plain t#eoretical foun!ation of EA $it# its origination) !e&nition)
$ays to ma+e it tailore!) a!justments re-uire!) scope an! some ot#er
relate! issues% /#e met#o!ology use! is a type of t#eoretical mining of
logics resulting a step("y(step process re-uire! for EA implementation% As
corporate #ouse plans to move from tra!itional to value "ase! performance
measures) EA $oul! yiel! goo! result%
Key Words: Economic Value Added, Market Value Added, Net Present Value, Weighted Average
Cost of Capital
INTRODUCTION
Performance Measurement systems was developed as a means of monitoring and maintaining
organisational control, which is the process of ensuring that an organisation pursues strategies
that lead to the achievement of overall goals and o!ectives" Performance Measurement plays a
vital role in every organisation as it is often viewed as a forward#looking system of
measurements that assist managers to predict the company$s economic performance and spot the
need for changes in operations" %n addition, PM can provide managers, supervisors and operators
with information re&uired for making daily !udgments and decisions" PM is increasingly used y
organisations, as it enales them to ensure that they are achieving continuous improvements in
their operations in order to sustain a competitive edge, increase market share and increase profits"
'easons for adapting performance measurements(#
1. )o evaluate the performance of firm*department*individual"
2. )o control different activities so that it leads to achieve organi+ational goal"
3. )o udget according to the future re&uirement"
4. )o motivate y giving people significant goals to achieve and then use performance
measures to provide periodic sense of accomplishment"
TRADITIONAL MEASURES
)raditional PM has mainly een financial measuring ratios such as ',% -'eturn on %nvestment.,
'% -'esidual %ncome., and EP/ -Earnings per share." )hese metrics accounts for the costs
associated with capital and help firms spot areas in which capital is eing invested unprofitaly"
Although these financial data have the advantage of eing precise and o!ective, the limitations
are far greater, making them less applicale in today$s competitive market" ,rganisations, that
have adopted the traditional PM, have e0perienced great difficulty in trying to fit the measures
with increasing new usiness environment and current competitive realities"
While the traditional financial metrics are value#ased, they are nonetheless lagging indicators"
)hey offer little help for forward#looking investments, where future earnings and capital
re&uirements are largely unknown investments such as new product introductions and capital or
new market entry"
1ail to measure and monitor multiple dimensions of performance, y concentrating
almost e0clusively on financial measure"
)hey solely concentrate on minimising costs and increasing laour efficiency while
neglecting other operational performance measures such as &uality, responsiveness and
fle0iility"
Allowing managers to use slow#reacting and tactical management control system such as
$udgets$" )hese udgeting measures mainly focus on short#term value creation as it only
attempts to control and improve e0isting operations"
Moreover, most companies motivate their worker through reward system" )raditionally,
employees are rewarded with onuses at the end of the year once a specific target has
een achieved" 2owever, this reward system causes short#termism as employees are seen
to narrow down their focus y !ust targeting the $rewarded$ goal"
)hus, ma0imi+ing shareholders value is ecoming the new corporate standard in the world"
/hareholder3s wealth is measured in term of the returns they receive on their investment" )he
returns can either e in the form of dividends or in the form of capital appreciation or
oth" Capital appreciation depends on the suse&uent changes in the market value of the
shares" )his market value of shares is influenced y a numer of factors, which can e company
specific, industry specific and macro#economic in nature" )o help corporate to generate
value for shareholders, value#ased management systems have een developed" %ndeed, value#
ased management, which seeks to integrate finance hypothesis with strategic economic
philosophy, is considered as one of the most significant contriutions to corporate financial
planning in the last two decade or so"
Many of the traditional corporate performance measures have een found to poorly correlate,
or even conflict, with management$s primary o!ective which is ma0imi+ing the market value
of a firm$s stock" Now, there are several new measures in the financial world that attempt to
align the ehaviors of an organi+ation with its stockholders$ interests" ,ne measure that has
received a great deal of notice and acceptance is Economic Value Added -EVA. which developed
y 4oel M" /tern and 5" 6ennett /tewart 7 Co" %mplementation of one of these measures,
such as EVA, can fundamentally change the ehavior of an entire organi+ation" )he new
measure focuses the ehavior of individuals throughout all parts of the organi+ation in a way
that is etter aligned with creating stockholder wealth" 6ecause performance compensation
incentives are ased upon the new measure, employees and stockholders mutually enefit"
)he EVA frame work, which is ecoming more and more desirale tool for measuring the
financial performance of corporates, offers a consistent approach to set goals and measure
performance, communicate with investors, evaluate strategies, allocate capital valuing
ac&uisitions and determine incentive onuses" 2owever, the EVA implementing and
improvement process is one of the several ongoing initiatives for a new corporate"
Economic Value Added -EVA. is a value ased performance measure that gives importance on
value creation y the management for the owners" Profit ma0imi+ation as a concept is age#old,
wealth ma0imi+ation is matured and value ma0imi+ation is today3s wisdom" /tern /tewart3s EVA
raises storm in corporate world and gives a new way to think aout rewarding management"
8saility of EVA largely depends on the &uality of accounting information system, as traditional
information system will not provide sufficient information to compute true EVA" )hus, EVA is
re&uired to e tailored in line with accounting system, management philosophy and the degree of
demand of such a system" %n this paper, an earnest effort has een made to e0plain theoretical
foundation of EVA with its origination, definition, ways to make it tailored, ad!ustments
re&uired, scope and some other related issues" )he methodology used is a type of theoretical
mining of logics resulting a step#y#step process re&uired for EVA implementation" As corporate
house plans to move from traditional to value ased performance measures, EVA would yield
good result"
EVA: EVOLUTION AND GROWTH
/tern /tewart defines EVA as the difference etween a company$s net operating income after
ta0es and its cost of capital -/tern /tewart, 9::;." )he idea is that the value -positive or negative.
a company creates over a period of time is determined y its actual financial performance minus
the cost of capital re&uired to fund the performance" %n essence, /tern /tewart took
an accounting#ased metric, residual income -'%. that has e0isted for several decades and
reathed new life into it y manufacturing a very attractive acronym, EVA"
At first glance this appears almost identical to the definition of EVA and raises the &uestion as to
whether EVA is simply another name for '%" )here are, however, some important differences" %n
general, '% does not ad!ust accounting earnings or accounting assets in calculating the level
of '% generated y an organi+ation during a given time span" %n essence, '% is a simplified form
of EVA" %t means EVA is not a newer innovation" 'esidual income is defined as operating profit
sutracted with capital charges" EVA is thus, one variation of residual income with ad!ustments
to how one works out income and capital" According to Wallace, one of the earliest to point out
the residual income concept was Alfred Marshall in 9<:=" Marshall descried economic profit as
total net gains less the interest on invested capital at the current rate"
9
2owever residual
income has een used y companies for years" 1or e0ample, 5eneral Electric -5E. used
residual income in the 9:>=s and 9:?=s to measure performance"
@uring 9:A=s, the residual income concept did not get enough pulicity and it did not finish up
to e the prime performance measure of companies" 2owever EVA, practically, the same
concept with a different name, has come to fore in to fore in the recent years" Moreover, the
propagation of EVA and residual income measure does not seem to e on an aating trend" ,n
the contrary, the numer of companies adopting EVA is increasing rapidly" ,ne can only
guess why residual income did never gain recognition of this level" ,ne of the possile
reasons is that Economic Value Added was marketed with a concept of Market Value Added
-MVA. and it did offer a hypothetically significant connection to market valuations"
B
)his
relation can e oserved clearly in the definition of EVA y /tern and /tewart -9::=." )hey
e0pressed it appropriately(
CEVA reflects a reality of the stock market and a reality of the capitalist society we live in" )he
reality is that all companies are in the same usiness which is to make efficient use of scarce
capital resources" )o e successful, companies must essentially CeatC their respective capital
associates" )hey must earn returns on scarce capital that e0ceed the returns offered y its
capital competitors who are also competing for scarce capital" Companies that succeed will add
value to invested capital" )he stock will then trade at premium to reflect this" Companies that
don$t succeed will essentially misallocate or misuse capital" )he market will discount the stock
accordinglyDC
)he only significant difference etween '% and EVA is the financial statements used in the
calculations" /tern /tewart elieves that traditional financial statements do not ade&uately
reflect the underlying economic events associated with the enterprise" %t argues that 5AAP#
ased performance measures are distorted and must e ad!usted to otain meaningful metrics"
1or e0ample, 5AAP re&uires e0pensing 'esearch 7 @evelopment -'7@. in the period incurred"
%t can e argued that '7@ enefits future periods and should e capitali+ed" 2ence, in a year
1
Alfred Marshal, The Principles of Economics, 1890, Chapter-4, p !"
"
# #erold $immerman, E%A and &i'isional Performance Meas(rement)
Capt(rin* +,ner*ies and other iss(es, #o(rnal of Applied Corporate -inance, s(mmer 199.,
%ol 10, /o ", pp 11!-1"0
of relatively high '7@, 5AAP statements will understate income statement earnings and
alance sheet accounts" )o correct for such distortions, /tern /tewart suggests a list of
specific ad!ustments that add e&uity e&uivalent reserves to capital and periodic changes in
the reserves to after#ta0 operating profits -/tewart, 9::9E /tern /tewart, 9::;." E0amples of
the e&uivalent reserves include items such as( deferred %ncome ta0 reserves, F%1,
reserves, cumulative goodwill amorti+ation, unrecorded goodwill, intangiles not
capitali+ed, allowance for doutful accounts, and other reserves"
EVA is a powerful tool for several reasons( %t aligns employee ehavior with stockholder value
generation, separates employee incentive compensation from the traditional performance
measurement that compares actual to udgeted results, and it is relatively easy to communicate
and understand" EVA can ring great value to a company y focusing the entire organi+ation on
activities that produce results valued y shareholders" With a well#grounded
understanding of EVA, the financial organi+ation is uni&uely capale of providing counsel that
will ensure successful implementation of this new measure"
WHAT IS ECONOMIC VALUE ADDED (EVA)?
Economic Value Added -EVA. is the financial performance measure that comes closer than any
other to capturing the true economic profit of an enterprise" )hus, in modern economics and
finance area, EVA holds an important part that has less deate among practitioners" %t is the
performance measure most directly linked to the creation of shareholders wealth over time"
/hareholders are very much choosy for their interest into the usiness and they like management
to come up with very specific solution" 6y the time, it is estalished that the very logic of using
EVA is to ma0imi+e the value for the shareholders" More e0plicitly, EVA measure gives
importance on how much economic value is added for the shareholders y the management for
which they have een entrusted with" EVA is e0ceptional from other traditional tools in the sense
that all other tools mostly depend on information generated y accounting" And we know
accounting more often produces historical data or distorted data that may have no relation with
the real status of the company" 6ut, EVA goes for ad!ustments to accounting data to make it
economically viale"
8nder conventional accounting, most companies appear profitale ut many in fact are not" As
Peter @rucker put the matter in a 2arvard 6usiness 'eview article, C8ntil a usiness returns a
profit that is greater than its cost of capital, it operates at a loss" Never mind that it pays ta0es as
if it had a genuine profit" )he enterprise still returns less to the economy than it devours in
resourcesDuntil then it does not create wealthE it destroys it"C Company may intentionally
pay ta0 to prove that they have made profit for their shareholders and thus a falsification is done
with owners that is not a rare corporate practice" EVA corrects this error y e0plicitly recogni+ing
that when managers employ capital they must pay for it, as if it were a wage" %t also ad!usts all
distortions that are very much prevalent in the information generated y
conventional accounting" )hus, it is the most demanded tool for the owners in every situation" %t
has een implemented in numerous large companies to motivate managers to create shareholder
value -@odd and Chen, 9::?." )he decision role is very simpleE if the EVA is positive, the
company creates shareholder wealth" Negative EVA indicates that shareholder wealth is
destroyed -/tewart, 9::9." @e facto, EVA is the same as residual income -'%. that has een in
e0istence for several decades" )he only significant difference etween the two lies in the
handling of accounting distortions -@odd and Chen, 9::A." EVA removes e0isting distortions y
using up to 9?G ad!ustments to traditional accounting data -/tewart, 9::9E 6lair, 9::A." )hese
distortions are disregarded in the '% calculation" %n this chapter, an earnest effort has made to
introduce EVA as a value ased performance measurement tool"
EVA-Economic Value Added. was developed y a New Hork Consulting firm, /tern /teward 7
Co in 9:<B to promote value#ma0imi+ing ehavior in corporate managers" )his term has een
used in the ook named The Quest for Value which was pulished in 9::9" /tern /teward 7
Co claims EVA to e their registered trade mark, while Peter @rucker claimed that he discussed
EVA in 9:?G in his ook, Managing for Results. %t cannot e deniedE however, without going
into argument as to who invented EVA first that the concept ecame popular only after /tern
/tewart 7 Co" marketed it"
EVA is a value#ased measure that was intended to evaluate usiness strategies, capital pro!ects
and to ma0imi+e long#term shareholders wealth" Value that has een created or destroyed y the
firm during the period can e measured y comparing profits with the cost of capital used to
produce them" )he detailed analysis using EVA may enale the managers to find out activities
which are less profitale, and where the profits are eing Ieaten#up$" EVA, therefore enales the
management to, invest in pro!ects that are critical to shareholder$s wealth" )his will lead to an
increase in the market value of the company" 2owever, activities that do not increase
shareholders value might e critical to customer$s satisfaction or social responsiility" 1or
e0ample, ac&uiring e0pensive technology to ensure that the environment is not polluted might
not e of high value from a shareholder$s perspective" 1ocusing solely on shareholder$s wealth
might !eopardi+e a firm reputation and profitaility in the long run"
'esearchers have found that managers are more likely to respond to EVA incentives when
making financial, operational and investing decision -6iddle, 5ary, Managerial finance 9::<.,
allowing them to e motivated to ehave like owners" 2owever this ehavior might lead to some
managers pursuing their own goal and shareholder value at the e0pense of customer satisfaction"
8nlike traditional methods of performance measurement, EVA focuses on ends and not means" %n
other words, we can say that it does not state how manager can increase company$s value as long
as the shareholders wealth is ma0imi+ed"
%f we talk aout the corporate houses, Cola#Cola is one of the many companies that adopted EVA
for measuring its performance" %ts aim, which was to create shareholders wealth, was announced
in its annual report" )he EVA calculation showed that Coca#Cola$s investor received J<"?; wealth
for every dollar they invested
Mathematically, the EVA can e calculated as(
COMPONENTS OF EVA
Cal!la"#$% $& N'" O(')a"#%* P)$&#" a&"') Ta+', (NOPAT)
N,PA) is easy to calculate" 1rom the income statement we take the operating income and
sutract ta0es" ,perating income is sales less cost of sales and less selling, general and
administrative e0penses" )he following e0ample from KHL Company illustrates the N,PA)
calculation(
KHL Co" -1.
/ales BG,;?,===
Cost of goods /old 9A,==,===
##############
5ross Profit A,;?,===
Fess(
Administrative, 5eneral
7 /elling E0penses G,==,===
##############
,perating Profit ;,;?,===
Fess(
)a0es M >=N 9,?<,===
##############
N,PA) 9,?<,===
COST OF CAPITAL
Many usiness don3t know their true cost of capital, which means that they proaly don3t know
if their company is increasing in value each year" )here are two types of capital, orrowed and
e&uity" )he cost of orrowed capital is the interest rate charged y the ondholders and the
anks" E&uity capital is provided y the shareholders" An investor3s e0pected rate of return on an
investment is e&ual to the risk free rate plus the market price for the risk that is assumed with the
investment" )he relationship etween e0pected return and risk is measured y comparing a
company to the market"
)he risk of a company can e decomposed into two parts" An investor can eliminate the first
component of risk y comining the investment with a diversified portfolio" )he diversifiale
EVA - NOPAT . (WACC Ca(#"al E/(l$0'1)
- N'" O(')a"#%* P)$&#" . Ta+', . C$," $& Ca(#"al
Where,
N,PA) means Net ,perating Profit efore %nterest and after )a0
WACC represents Weighted Average Cost of Capital"
component of risk is referred to as non#systematic risk" )he second component of risk is non#
diversifiale and is called the systematic risk" %t stems from general market fluctuations which
reflect the relationship of the company to other companies in the market" )he non#diversifiale
risk creates the risk premium re&uired y the investor" %n the security markets the non#
diversifiale risk is measured y a firm3s eta"
)he higher a company3s non#diversifiale risk, the larger is their eta" As the eta increases the
investor3s e0pected rate of return also increases" Current estimates of eta for a wide variety of
companies are availale from Value Fine and 6loomerg" /hareholders usually e0pect to earn
aout si0 percent more on stocks than government onds" With long term government onds
earning A">N, a good estimate for the cost of e&uity capital would e aout 9;"> N" )he true cost
of capital would e the weighted average cost of det and e&uity"
MEASURING CAPITAL EMPLO2ED
)he ne0t step is to calculate the capital that is eing used y the usiness, from the economist
point of view" Accounting profits differ from economic profits" 8nder generally accepted
accounting principles, most companies appear to e profitale" 2owever, many actually destroy
shareholder wealth ecause they earn less than the full cost of capital" EVA overcomes this
prolem y e0plicitly recogni+ing that when capital is employed it must e paid for"
%n financial statements, created using generally accepted accounting principles, companies pay
nothing for e&uity capital" As discussed earlier, e&uity capital is very e0pensive" Economic
profits are defined as total revenues less total costs, where costs include the full opportunity cost
of the factors of production" )he opportunity cost of capital invested in a usiness is not included
when calculating accounting profits"
Capital would include all short and long term assets" %n addition, other investments that has een
e0pensed using accrual accounting methods are now included as capital" 1or e0ample, research
and development, leases, and training, which are investments in the future, that 5AAP re&uires
to e e0pensed in the year they occur, would e treated as a capital investment and assigned a
useful life" %f the usiness invest in developing new products this year, that amount would e
added ack to operating profits and to the capital ase" %f the product has a five#year life, deduct
9*> of the investment would e deducted each year from operating profits and from the capital
ase in each of the ne0t five years"
FUNDAMENTAL CONCEPT OF EVA
EVA is the amount of economic value added for the owners y management" )he thrust area for
today3s management is to find means to create value for the owners" %t is now estalished that the
accounting profit in no cases represents the real value created for the owners" 6ut, it may
originate the calculation" %n other words, accounting profit is re&uired to
e converted into economic profit" 8nder EVA, all distortions in conventional accounting are
identified and accounting profit is ad!usted to make it distortion free and finally we get the
amount of EVA" /tewart defined EVA -9::=, p"9;A. as Net operating profit after ta0es -N,PA).
sutracted with a capital charge" Algeraically, it can e stated as follows(
EVA O N,PA) 2 Capital Cost
N,P -9#). 2 Capital Emplo,ed 3 Cost of Capital
Ad!usted N,P -9#). 2 Capital Emplo,ed 3 4ACC
Ad!usted N,P -9#).
'eturn 2 Capital Emplo,ed 3 4ACC
-'ate of ',% 2 4ACC5 Capital Emplo,ed
66666666666666666666667 eq. 1)
1rom the aove derivation it is clear that EVA computation re&uires a lot of hurdles to e passed"
Net operating profit is ad!usted for accounting distortions and a charge on capital employed at
the rate of weighted average cost of capital -WACC. is sutracted from N,PA) to reach to the
amount of EVA" %t aims to tell aout what happens to the wealth of shareholders" As per e&uation
9, earning a return greater than the cost of capital increases value for the owners and vice versa"
1or listed companies /tewart defined another measure that assesses if the company has created
shareholder value" %f the total market value of a company is more than the amount of capital
invested in it, the company has managed to create shareholder value" %f the case is opposite, i"e",
the market value is less than the amount of capital investedE the company has destroyed
shareholder value" /tewart -9::=, p"9>;. calls it as Market Value Added -MVA. and can e
e&uated as follows(
MVA O Market Value of the Company 2 Capital %nvested
Market Value of E&uity 2 6ook Value of E&uity -assuming Capital invested O 6V of E&uity.
-MV P 6V. Numer of /hares ,utstanding
Present Value of All 1uture EVA 333333333333333333333('4. 2)
%n other words,
Market Value of E&uity O 6ook Value of E&uity 8 Present Value of All 1uture EVA""""""""""
('4. 3)
MVA is identical y meaning with the market#to#ook ratio" )he difference is only that MVA is
an asolute measure and market#to#ook ratio is a relative measure" %f MVA is positive that
means that market#to#ook ratio is more than one" Negative MVA means market#to#ook ratio
less than one" %f a company3s rate of return e0ceeds its cost of capital, the company will sell on
the stock markets with premium compared to the original capital -has positive MVA." ,n the
other hand, companies that have rate of return smaller than their cost of capital sell with discount
compared to the original capital invested in company" Whether a company has positive or
negative MVA depends on the level of rate of return compared to the cost of capital" All this
applies to EVA also" )hus positive EVA means also positive MVA and vice versa"
6ut, MVA is not a performance metric like EVA, rather it is a wealth metric, measuring the level
of value a company has accumulated over time"
THE CONCEPT OF MAR5ET VALUE ADDED (MVA)
According to the theory of EVA, if a return on investment is greater than the cost of capital it
increases the value of a company while earnings less than the cost of capital decrease the value
of a company" Another measure that determines if the company has created shareholder value,
which is termed as Market Value Added, which holds that if the total market value of a company
is more than the amount of capital invested in it, the company has created shareholder value"
)hus, Market Value Added -MVA. is a measure of wealth a company has created for its
investors" %t is a cumulative measure of corporate performance that looks at how much a
company3s stock has added to -or taken out of. investors3 pocketooks over its life and compares
it with the capital those same investors put into the firm" Ma0imi+ing MVA should e the
primary o!ective for any company that is concerned aout its shareholders3 welfare" )he
difference etween the company3s market value and ook value is Market Value Added, as
defined y /tewart"
MVA - C$/(a%06, T$"al Ma)7'" Val!' . Ca(#"al I%8',"'1 9 $)
MVA - Ma)7'" Val!' $& E4!#"0 . :$$7 Val!' $& E4!#"0
I" a% al,$ ;' <)#""'% a,:
MVA - =(S>a)', $!","a%1#%* ? S"$7 ()#') @ Ma)7'" 8al!' $& ()'&'))'1 ,"$7
@ Ma)7'" 8al!' $& 1';"A . T$"al a(#"al
)he ook value of e&uity refers to all of the items that are not solvency issues for a company"
According to /tewart, the amount a company has added to, or sutracted from its shareholders
investment is the determinant of Market Value" %f a company3s rate of return e0ceeds its cost of
capital, the company will sell on the stock markets with a premium compared to the original
capital and this is what determines if the company has succeeded in creating Market Value" A
positive or negative MVA depends upon the ratio of rate of return to cost of capital, which is
similar to EVA" A positive or negative EVA is the same as a positive or negative MVA"
MVA - P)','%" Val!' $& All F!"!)' EVA (a, '+(la#%'1 a;$8')
F#*!)' : C$/(a%0B, /a)7'" 8al!' 1'('%1, 1#)'"l0 $% #", &!"!)' EVA.
)he relationship etween EVA and MVA has strong earing on valuation shown in the formula
elow(
Ma)7'" Val!' $& E4!#"0 - :$$7 Val!' $& E4!#"0 + P)','%" Val!' $& All F!"!)' EVA

t
t
1 t=
) WACC + (1
EVA
= MVA

)he MVA rate of return concept is similar to that of the yield on a ond" When a ond is issued
with a yield greater than the current market rate then the ond will sell at a premium -there is
positive EVA and so the ond will sell at positive MVA." %f the yield of a ond is lower than the
current market rate then the ond will sell at a discount -there is negative EVA and so the ond
will sell at negative MVA." /ince the valuation formula given aove is always e&ual to @C1 and
NPV, then the right estimate of value is always otained regardless of what the original ook
value of e&uity is"
)he implementation process of EVA parallels the successful implementation of /tern /tewart
GMs, e"g", measurement, management system, motivation and mindset" EVA at the very
eginning looks for a measurement ase for converting accounting profits into economic reality"
Without commitment from management, the implementation of EVA is impossile" Management
system should e streamlined with the asic EVA philosophy" %t should e guaranteed that the
application of EVA is well accepted y all" And finally, mindset should e cultivated into the
corporate culture to make it the focal point for reporting, planning and decision#making"
4 M6S OF EVA
/tern /tewart descries four main applications of EVA with four words eginning with the letter
M"(#
1. M'a,!)'/'%"
EVA is the most accurate measure of corporate performance over any given period" 1ortune
maga+ine has called it Ctoday$s hottest financial idea,C and Peter @rucker rightly oserved in
the 2arvard 6usiness 'eview that EVA is a measure of Ctotal factor productivityC whose
growing popularity reflects the new demands of the information age" %t rings goal
congruence or matching of employees and shareholders" %t provides significant information
eyond traditional accounting measures like ',%, ',CE, EP/, etc
2. Ma%a*'/'%" S0,"'/
While simply measuring EVA can give companies a etter focus on how they are performing,
its true value comes in using it as the foundation for a comprehensive financial management
system that encompasses all the policies, procedures, methods and measures that guide
operations and strategy" )he EVA system covers the full range of managerial decisions,
including strategic planning, allocating capital, pricing ac&uisitions or divestitures, setting
annual goals#even day#to#day operating decisions" )he management can use the EVA for
accessing the performance of the usiness units or segments within the company" %f the
segment is making surplus after achieving the cost of capital then it makes sense to invest
into it"
3. M$"#8a"#$%
)o instill oth the sense of urgency and the long#term perspective of an owner, /tern /tewart
designed cash onus plans that cause managers to think like and act like owners ecause they
are paid like owners" %ndeed, asing incentive compensation on improvements in EVA is the
source of the greatest power in the EVA system" 8nder an EVA onus plan, the only way
managers can make more money for themselves is y creating even greater value for
shareholders" )his makes it possile to have onus plans with no upside limits" %n fact, under
EVA the greater the onus for managers, the happier shareholders will e"
4. M#%1,'"
When implemented in its totality, the EVA financial management and incentive compensation
system transforms a corporate culture" 6y putting all financial and operating functions on the
same asis, the EVA system effectively provides a common language for employees across
all corporate functions" EVA facilitates communication and cooperation among divisions and
departments, it links strategic planning with the operating divisions, and it eliminates much
of the mistrust that typically e0ists etween operations and finance" )he EVA framework is,
in effect, a system of internal corporate governance that automatically guides all managers
and employees and propels them to work for the est interests of the owners" )he EVA
system also facilitates decentrali+ed decision making ecause it holds managers responsile
for#and rewards them for#delivering value"
EVA: AS A TOOL OF FINANCIAL MANAGEMENT MEASUREMENT
)he important goal of financial management is to create highest capital employees -owners 7
lenders. wealth and conse&uently enhancing the value of the firm" /hareholder wealth is
traditionally reflected y either standard accounting magnitudes -such as profits, earnings and
cash flow from operations. or financial statement ratios -including earnings per share and the
returns on assets, investment and e&uity." )his financial statement information is then used
y managers, shareholders and other interested parties to assess current firm performance, and
is also used y these same stakeholders to predict future performance" )he &uestion then
arises is whether these measures of corporate performance are linked to the
e0pectation of the shareholders"
)he prolem with these performance measures is that they lack a proper enchmark for
comparison" )he shareholders re&uire at least a minimum rate of return that the
aove mentioned performance measures ignore" Most of the time the enchmark used is the
industry average or the nearest competitor performance" 6ut the fact the industry
average or competitors performance may e elow what is re&uired y the investors is ignored"
/o a company may e earning returns etter than others in the industry ut it might not meet
the capital employee3s minimum e0pectations"
An appropriate performance measure should assess how managerial actions affect the
firm value" 1or this to e happen, the performance measure must incorporate at least three things"
a" the amount of capital invested
" the return earned on the capital and
c" the cost of capital -WACC.
)ale presents a comparison of profit, EP/, ',CE, ',E across the aove three parameters" %t
shows that those criteria have failed to capture the capital employees3 value
creation*destruction as a result of management actions" )here was a &uestion which indicators
can measure relialy the change in the value of the firmQ
A C$/(a)#,$% $& 1#&&')'%" ")a1#"#$%al (')&$)/a%' /'a,!)',
P')&$)/a%'
M'a,!)'
C$/(!"a"#$% I%l!1',
R'"!)% Ca(#"al E/(l$0'1 C$," $& Ca(#"al
E/(l$0'1
P)$&#"
EPS
ROCE
ROE
2',
2',
2',
2',
N$
2',
2',
2',
N$
N$
N$
N$
,ver the past several years, an alternative performance measure called Economic Value Added
-EVA. has een gaining acceptance in 8nited /tates" %t is acknowledged y institutional firms as
a credile performance measure" %n order to overcome the limitations of accounting
ased measures of financial performance, 4oel /tern postulated a modified concept of
economic profit in 9::= in the name of Economic Value Added -EVA. as a measure of usiness
performance"
/tern has claimed that EVA as a tool of financial management was neither !ust a phenomenon
not it is limited to Ifor profit3 organi+ations" Economic Value Added has een put to use
for management performance evaluation and much more than !ust a measure of performance, it
is the framework for a complete financial management -for improving scarce capital
allocationE and for valuation of a target company at the time of ac&uisition." Economic Value
Added, through the implementation of a complete EVA#ased 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 pulicly
owned or private enterprise" %t can improve the working lives of everyone in an organi+ation y
making them more successful and can help them produce greater wealth for shareholders,
customers, creditors and themselves"
EVA as a tool of financial measurement enlightens us whether the operating profit is enough
to cover the cost of capital" /hareholders must earn sufficient return for the risk they have
taken in investing their funds in company3s capital" )he return generated y the company for
shareholders has to e more than the overall cost of capital to !ustify risk taken y shareholders"
%f a company3s EVA is negative, the firm is destroying shareholders wealth even though it may
e reporting a positive and growing earning per share and return on capital employed Economic
Value Added simply alances a company$s profitaility against the capital it employs to generate
this profitaility" %f a company$s earnings, after ta0, e0ceed the cost of the capital
employed in the usiness, EVA is positive" Market studies have indicated that a company
that continually generates an increasingly positive EVA will e rewarded y a higher stock
price" ,f course, if a company$s long#term prospects are impaired, due to market conditions,
litigation, management change or some other reason, then its stock price will not necessarily
increase"
/everal evidences e0ist to support the relationship etween EVA and firm performance"
/pecifically, the advantage of EVA is that it tends to identify specific idle assets or, from a
portfolio of assets, identify those that provide the lowest economic return" Conse&uently, EVA
can e raised and y(
i" Earning more profit without using more capital,
ii" 8sing less capital, and*or
iii" %nvesting capital in high return pro!ects"
)he 1igure shows the relation among Cash from operations, accounting earnings, 'esidual
%ncome and Economic Value Added" %t summari+ed the steps that transform underlying cash flow
from operation -C1,. into economic value added -EVA."
EVA - CFO @ A)!al, @ AT I%" C Ca(. C>* @ A. A1D
N'" I%$/' (NI)
N'" O(')a"#%* P)$&#" A&"') Ta+ (NOPAT
R',#1!al I%$/' (RI)
E$%$/# Val!' A11'1 (EVA)
EVA - CFO @ A)!al, @ AT I%" C Ca(. C>* @ A. A1D
N'" I%$/' (NI)
N'" O(')a"#%* P)$&#" A&"') Ta+ (NOPAT
R',#1!al I%$/' (RI)
E$%$/# Val!' A11'1 (EVA)

C1, O Cash flow from operations

Accruals O Accrual introduced y the financial accounting process
N% O Net income efore e0traordinary items
A) %nt O After#ta0 interest -added ack to produce an operating performance numer that
is efore the cost of financing.
N,PA) O Net operating profit after ta0
Cap Chg O Charge for the estimated current cost of det and e&uity capital
Acc Ad! O /tern /tewart3s ad!ustments to N,PA) and Capital for alleged accounting
distortions
EVA O Economic value added -registered trade name of /tern /tewart 7 Company.
OTHER APPLICATIONS OF EVAC
Val!'C&$!,'1 D'#,#$% Ma7#%*
)o ma0imi+e shareholder wealth, decision makers at all levels must e value#focused" )he
market value of any firm is a function of its e0pected future performance, which in turn is a
function of the effectiveness of management" 1or Eg( # /tern /tewart 7 Co" helped clients
improve performance y etter understanding the value inherent in their strategy and operations"
)o assess the value of an ac&uisition target, analy+e the economics of a product portfolio,
formulating the structure of a compensation plan, or introducing a new financial management
framework, the approach for all pro!ects can e done from one vantage point #the strategy est
ma0imi+es the value creation of the usiness over time i"e" EVA"
Ma%a*'), W>$ T>#%7 a%1 A" l#7' O<%'),
)he most effective way to motivate managers is to make value#ased decisions is to link their
incentives to goals that relate directly to value creation itself" 8nder this type of incentive
structure, managers stand to gain sustantially when, for e0ample, EVA increasesE when EVA
falls, their incentive compensation should e at risk" %t helps in designing compensation system
for managers ased on EVA" )his approach effectively makes a manager think like an owner, and
provides strong motivation to make decisions that focus on the continuous improvement in EVA
P decisions that the market will reward"
A C$//#"/'%" "$ C$%"#%!$!, I/()$8'/'%"
A final condition for ma0imi+ing wealth is to focus on continuous improvement rather than
short#term goals" %nvestors don$t reward companies ecause managers have met their annual
udgetE they reward companies when managers regularly seek out and undertake initiatives that
improve long#term performance" /tern /tewart encourages clients to stay focused on continuous
improvement"
Val!' :a,'1 S")a"'*0 a%1 Ma%a*'/'%"
/tern /tewart$s mission is to help clients estalish clear, accountale links etween management
action and the creation of shareholder wealth" %n his view, the most effective way to align
management initiatives with shareholder interests is to implement a framework for decision#
making that is ased on the proprietary EVA measure" EVA has gained road acceptance in the
usiness community for its aility to help managers increase the value of their companies" More
than G== ma!or corporations, gloally, have adopted our EVA framework and een rewarded with
significant improvements in corporate performance and share price"
EVA V,. TRADITIONAL PERFORMANCE MEASURES
Conceptually, EVA is superior to accounting profits as a measure of value creation ecause it
recogni+es the cost of capital and, hence, the riskiness of a firm3s operations" 1urthermore EVA is
constructed so that ma0imi+ing it can e set as a target" )raditional measures do not work that
way" Ma0imi+ing any accounting profit or accounting rate of return leads to an undesired
outcome" 1ollowing paragraphs seek to clarify the enefits of EVA compared to conventional
performance measures"
EVA9 NPV 8,. IRR9 ROI
'eturn on capital is very common and relatively good performance measure" @ifferent
companies calculate this return with different formulas and call it also with different names like
'eturn on investment -',%., 'eturn on invested capital -',%C., 'eturn on capital employed
-',CE., 'eturn on net assets -',NA., 'eturn on assets -',A. etc" )he main shortcoming with
all these rates of return is in all cases that ma0imi+ing rate of return does not necessarily
ma0imi+e the return to shareholders" 1ollowing simple e0ample will clarify this statement( #
/uppose a group with two susidiaries" 1or oth susidiaries and so for the whole group the cost
of capital is 9=N" )he group names ma0imi+ing ',% as target" )he other susidiary has ',% of
9>N and the other ',% of <N" 6oth susidiaries egin to struggle for the common target and try
to ma0imi+e their own ',%" )he etter daughter company re!ects all the pro!ects that produce a
return elow their current 9>N although there would e some pro!ects with return -%''. 9BN #
9;N" )he other affiliate, in turn, accepts all the pro!ects with return aove <N" 1or a reason or
another -e"g" overheated competition. it does not find very good pro!ects, ut the returns of its
pro!ects lie somewhere near :N"
Fet3s suppose that oth susidiaries manage to increase their ',%" With the etter susidiary ',%
increases from 9>N to 9?N and with the not#so#good susidiary ',% increases from <N to <">N"
)he company3s target, increasing ',%, is achieved ut what aout the shareholder valueQ %t is
ovious that all the pro!ects of the not#so#good susidiary decrease shareholder value, ecause
the cost of capital is more than rate of return -and so the shareholders money would have een
etter off with alternative investments e"g" in the markets." 6ut the actions of the etter
susidiary are neither optimal for shareholders" ,f course shareholders will enefit from the
good -return over 9>N. pro!ects ut also all 9BN#9;N -actually all aove 9=N O cost of capital.
pro!ects should have een accepted even though they decrease current ',%" )hese pro!ects still
create and increase shareholder value"
As the aove e0ample demonstrates operations should not e guided with the goal to ma0imi+e
the rate of return" As a relative measure and without the risk component ',% fails to steer
operations correctly" )herefore capital can e misallocated on the asis of ',%" 1irst of all ',%
ignores the definite re&uirement that the rate of return should e at least as high as the cost of
capital" /econdly ',% does not recogni+e that shareholders3 wealth is not ma0imi+ed when the
rate of return is ma0imi+ed" /hareholders want the firm to ma0imi+e the asolute return aove
the cost of capital and not to ma0imi+e percentages" Companies should not ignore pro!ects
yielding more than the cost of capital !ust ecause the return happens to e less than their current
return" Cost of capital is much more important hurdle rate than the company$s current rate of
return"
,serving rate of return and making decisions ased on it alone is similar to assessing products
on the Cgross margin on salesC #percentage" )he product with the iggest Cgross margin on salesC
#percentage is not necessary the most profitale product" )he product profitaility depends also
on the product volume" %n the same way are high rate of return should not e used as a measure
of a company$s performance" Also the magnitude of operations i"e" the amount of capital that
produces that return is important" 2igh return is a lot easier to achieve with tiny amount of
capital than with large amount of capital" Almost any highly profitale company can increase its
rate of return if it decreases its si+e or overlooks some good pro!ects, which produce a return
under the current rate of return"
)he difference etween EVA and ',% is actually e0actly the same as with NPV -Net present
value. and %'' -%nternal rate of return." %'' is a good way to assess investment possiilities, ut
we ought not to prefer one investment pro!ect to the other according to their %''" Assume two
good and e0clusive investment pro!ects, Pro!ect 9 and Pro!ect B" Pro!ect 9 has lower %'' ut is
much igger in scope -igger initial investment and igger cash flows and igger NPV." Pro!ect
9 -the pro!ect offering lower %''. is etter for shareholders even though it has lower %''" )hat is
ecause it provides igger asolute return than Pro!ect B" )he reason is e0actly same as with
',%( ma0imi+ing rate of return percentage does not matter" What matters is the asolute amount
of shareholders3 wealth added"
%n the corporate control it is worth rememering that EVA and NPV go hand in hand as also ',%
and %''" )he formers tell us the impacts to shareholders wealth and the latter tell us the rate of
return" )here is no reason to aandon ',% and %''" )hey are very good and illustrative measures
that tell us aout the rate of returns" %'' can always e used along with NPV in investment
calculations and ',% can always e used along with EVA in company performance" 2owever,
we should never aim to ma0imi+e %'' and ',% and we should never ase decisions on these two
metrics" %'' and ',% provide us additional information, although all decisions could e done
without them" Ma0imi+ing rate of returns -%'', ',%. does not matter, when the goal is to
ma0imi+e the returns to shareholders" EVA and NPV should e in the commanding role in
corporate control and ',% 7 %'' should have the role of giving additional information"
R'"!)% $% '4!#"0 (ROE)
',E suffers from the same shortcomings as ',%" 'isk component is not included and hence
there is no comparison" )he level of ',E does not tell the owners if company is creating
shareholders wealth or destroying it" With ',E this shortcoming is however much more severe
than with ',%, ecause simply increasing leverage can increase ',E" As we all know,
decreasing solvency does not always make shareholders3 position etter ecause of the increased
-financial. risk" As ',% and %'', return on e&uity -',E. is also an informative measure ut it
should not guide the operations"
Ea)%#%*, a%1 'a)%#%*, (') ,>a)' (EPS)
EP/ is raised simply y investing more capital in usiness" %f the additional capital is e&uity
-cash flow. then the EP/ will rise if the rate of return of the invested capital is !ust positive" %f the
additional capital is det then the EP/ will rise if the rate of return of the invested capital is !ust
aove the cost of det" %n reality the invested capital is a mi0 of det and e&uity and the EP/ will
rise if the rate of return of that additional capital invested is somewhere etween cost of det and
+ero" )herefore EP/ is completely inappropriate measure of corporate performance and still it is
very common yardstick and even a common onus ase" EP/ and earnings can e increased
simply y pouring more money into usiness even though the return on that money would e
entirely unacceptale from the viewpoint of owners" EP/, earnings and earnings*EP/ growth
should therefore e aandoned as performance measures"
ADVANTAGES AND DISADVANTAGES OF EVA
A18a%"a*', $& EVA
EVA is more than !ust performance measurement system and it is also marketed as a
motivational, compensation#ased management system that facilitates economic activity and
accountaility at all levels in the firm"
/tern /tewart reports that companies that have adopted EVA have outperformed their
competitors when compared on the asis of comparale market capitali+ation"
/everal advantages claimed for EVA are(
EVA eliminates economic distortions of 5AAP to focus decisions on real economic
results
EVA provides for etter assessment of decisions that affect alance sheet and income
statement or tradeoffs etween each through the use of the capital charge against N,PA)
EVA decouples onus plans from udgetary targets
EVA covers all aspects of the usiness cycle
EVA aligns and speeds decision making, and enhances communication and teamwork
Academic researchers have argued for the following additional enefits(
5oal congruence of managerial and shareholder goals achieved y tying compensation of
managers and other employees to EVA measures
6etter goal congruence than ',%
Annual performance measured tied to e0ecutive compensation
Provision of correct incentives for capital allocations
Fong#term performance that is not compromised in favor of short#term results
Provision of significant information value eyond traditional accounting measures of
EP/, ',A and ',E
L#/#"a"#$%, $& EVA
EVA also has its critics" )he iggest limitation is that the only ma!or pulicly#availale sample
evidence on the evidence of EVA adoption on firm performance is an in#house study conducted
y /tern /tewart and e0cept that there are only a numer of single#firm or industry field studies"
EVA does not control for si+e differences across plants or divisions
EVA is ased on financial accounting methods that can e manipulated y managers
EVA may focus on immediate results which diminishes innovation
EVA provides information that is ovious ut offers no solutions in much the same way
as historical financial statement do"
5iven the emphasis of EVA on improving usiness#unit performance, it does not
encourage collaorative relationship etween usiness unit managers
EVA although a etter measure than EP/, PA) and ',NW is still not a perfect measure
EVA IN INDIAN CORPORATES
)he corporate procedures have undergone through a deep#seated change in the modern time and
the use of traditional financial variales to e0plain the ehaviour of the present capital market is
not an appropriate move toward" 1urther, in the changing corporate environment, the
time has come to ga+e at association etween financial variales and stock prices or market
risk in different way"
,ne outcome of the economic reforms implemented in 9::=3s in most of the countries around
the gloe is that the whole world is ecoming a universal economy and the si+e of usiness
entities has een increasing" )his has een happening ecause, in order to compete in the world
market, an organi+ation needs to have si+ale resources and the capaility to e the est
performer of these resources"
A &uestion that arises, as organi+ations grow in si+e, get decentrali+ed and are put
into units, is that of financial performance evaluation" )he financial performance
evaluation measure used needs to e accurate, consistent, and gloally analogous and should
lead to goal similitude etween the owners and managers" When all is said and is done, leading
multinational companies, worldwide have already adopted EVA#ased system financial
management that out the system ahead of its competitors" %n such circumstances, the
%ndian corporates simply may not stay ehind for understanding and implementing the
concept" )he corporates in %ndia need to e fully e&uipped with Iifs3 along with Iuts3 of EVA
!ust not for the reason of gloal competition ut for their long#standing persistent
survival"
,utstanding and competent management or good corporate governance or a system for
shareholders3 value conception, these are popular terms" Everyody speaks on the su!ect within
and outside the corporate organi+ation, ut not many are aware of as what to do and what not to
do with reference to this concept" ,n the other hand, the concept of good corporate governance is
here to stay in this country and shareholders and financial institutions turn more down to
usiness, feels )e!pavan 5andhok, country Manager, %ndia for /tern /tewart 7 Company"
According to him,R %ndia companies on the whole have a poor average in wealth
creation"R ,ver G== companies3 worldwide implement the economic value added -EVA.
program, ut it is still relatively a new#metric and &uite emerging techni&ue for corporate
performance measurement in %ndia"
)he EVA analysis, un&uestionaly, has attracted much attention in the Western countries oth as
a management innovation as well as stock market analysis" )he recognition of such a techni&ue
in %ndian conte0t, nevertheless, shows to some e0tent diverse trends" Ma!ority of
companies are still not prepared to put in the EVA techni&ue for evaluating their financial
performance ecause of certain inherent difficulties associated with the computation" 6ut in a
country like %ndia where capital is still costly, one would have thought, corporate managements
would e trying to get a igger return for every rupees invested in the usiness" )his will
e happened y utili+ing the new performance measure, EVA" %t is emerging out from the
discussion made aove that the gloal market place is asking for some change in the role of
policy#makers and managers in corporate sector" As information systems get more refined,
managers will have the task of providing top management with information that is gloally
competitive for corporate decision#making" EVA is a measure that should e used y top
management to evaluate investment centre managers ecause it considers goal picture
etween shareholders and corporate managers"
'ecently a lot of emphasis is eing positioned on EVA rather than ',%, as a measure of
corporate performance in the %ndian financial literature" 2owever, using the concept may not e
suitale since it is not without deficiencies and pitfalls" Certain disputes regarding EVA
calculation and implementation have een highlighted y /ateesh Sumar -B===." /ome of
the important pitfalls in the use of EVA revealed y them are as follows(
Most of %ndian companies suffer from over#capacity situations, which distort the EVA
results"
EVA analysis does not give any idea aout the financial performance of
companies that are affected y usiness cycle variations"
Possiility of error in calculating N,PA) and also estimating WACC is another gray area"
When EVA is used as a measure to evaluate the performance of managers and their units,
they feel reluctant to ac&uire new fi0ed assets even if the circumstances demand so"
@espite all these arguale issues, EVA has made a position for itself not only in the Western
usiness community ut also in the %ndian corporate sector" 2owever, the recognition of this
concept in %ndia is gradually picking up and it is e0pected that in the coming years, more and
more %ndian companies will start relying upon this new measure of financial performance"
)his would, possily, catch the attention of policy#makers at 5overnment level,
corporate level, and N5,3s engaged in investors3 protection to press the corporate managers
to come up to the e0pectation of shareholders in the country" With the appearance of EVA,
the managers may e &uite aware aout the e0pected return y shareholders which is
invarialy higher than return e0pected y the det holders" )hat is why, now a days, the
corporate superiors are eing re&uired to work on the model of trading on e&uity that would
design some surplus for e&uity shareholders" )his surplus, if placed under technical terminology,
may lead to positive EVA for the organi+ation"
%n view of the aove fact, the competent authorities in %ndia like %CA%, /E6% and Company Faw
6oard should issue wide#ranging guiding principles for the computation of EVA and its practices
in financial reporting and accounting disclosures y the corporate world" %t further e0pected
from %CA% to issue necessary guidelines to the appropriate odies in the country so that it may
ecome oligatory for %ndian companies to disclose their EVA in the financial statements"
A CASE STUD2 OF HINDUSTAN UNILEVER LIMITED
O;D'"#8', $& ">' S"!10
)his study has the following o!ectives(
9" )o e0amine whether 2industan 8nilever Fimited -28F. has een ale to generate value
for its shareholders"
B" )o compute the performance of the company y applying traditional performance
indicator like ',% and the new corporate performance measure EVA"
1ollowing is the performance measurement of 28F for > years from B==B to B==? ased on
information given"
-All 1igures in 's" Crore.
PARTICULARS 2EEF 2EEG 2EE4 2EE3 2EE2
1. D';" 9?; ;?= 9><< <<9 G>
2. E4!#"0 B>9> BB== B99? B<:: ;;>9
3. Ca(#"al '/(l$0'1(1@2) B?A< B>?= ;A=G ;A<= ;;:?
4.P)$&#" a&"') "a+ (PAT) 9>G= 9;>> 99:: 9<=G 9A9?
G.ROI H (4I3)
F.C$," $& D';"9 ($,"C"a+ H
GJ.G1
>":
G2.K3
;";<
32.3J
>"9:
4J.J2
G"<<
GE.G3
?"G>
J.C$," $& E4!#"0 H 9?";< 9>"> 9G"AA 9B":? 9G"G
L.W'#*>"'1 A8')a*' C$," $& Ca(#"al H
(WACC)
9>"AG 9;"< 9="?? 99"=A 9G";
K.C$," O& Ca(#"al E/(l$0'1 (3ML) 421.G2 3G3.2L 3K4.LG 41L.4G 4LG.F3
ECONOMIC VALUE ADDED(EVA)
1E.P)$&#" a&"') "a+ (PAT) 9>G= 9;>> 99:: 9<=G 9A9?
11.A11:I%"')',"9a&"') "a+', A 9B <B G; ?
12.N'" $(')a"#%* ()$&#", A&"')
Ta+',(NOPAT)
9>GA 9;?A 9B<9 9<GA 9ABB
13.COCE 9a, (') (J) a;$8' GB9 ;>; ;:> G9< G<?
14.EVA:(12C13) 112F 1E14 LLF 142K 123F
E$%$/# Val!' a11'1 a%1 ROI &$) ">' la," &#8' 0'a), #, *#8'% ;'l$<:
R,
. C)$)',
2EARS EVA CAPITAL
EMPLO2ED
EVA AS H OF
CAPITAL
EMPLO2ED
RETURN ON
INVESTMENT
(ROI)
2EE2 123F 33KF 3F.4H GE.G3H
2EE3 142K 3JLE 3J.LH 4J.J2H
2EE4 LLJ 3JE4 23.KH 32.3JH
2EEG 1E14 2GFE 3K.FH G2.K3H
2EEF 112G 2FJJ 42.EH GJ.G1H
RETURN ON INVESTMENT (ROI) FOR HUL
ECONOMIC VALUE ADDED (R,. C)$)') OF HUL
)he aove tale shows that divergence e0ists etween the performance results given y
traditional measure -ased on ',%. and percentage of EVA on Capital Employed" )he 'eturn on
%nvestment -',%. does not reflect the real value addition to shareholders3 wealth and it is not
possile to !udge the efficiency of any decision, value creation or value addition aspect is of
utmost importance in the present ackdrop of corporate governance ut EVA ased performance
measurement system give an idea clearly aout the shareholders value addition or value
destruction" )he company has een successfully ale to create value for its shareholders during
the study period"
)his clearly shows that 28F is creating value for its shareholders ased on EVA calculated over
a period of > years" )hus Economic value Added -EVA. is increasingly eing applied to
understand and evaluate financial performance of an organi+ation"
CONCLUSION
Economic profit # otherwise known as CEconomic Value AddedC -EVAT. is ased on classic
financial theory, and, for this reason, is not entirely different from traditional free cash flow
measures" )hree conceptual pillars support economic profit( firstly, Cash flows are more reliale
than accruals" /econd is that some period e0penses are # in economic reality # actually long#term
investments" Fastly, the company does not create value until a threshold level of return is
generated for shareholders"
2owever, economic profit is an appropriate performance metric for the company to e evaluated
and one can identify the many pros and cons in the process of its application" With only one
single performance numer, economic profit is proaly the est ecause it contains so much
information -mathematicians would call it CelegantC.( economic profit incorporates alance sheet
data into an ad!usted income statement metric" Economic profit works est for companies
whose tangile assets -assets on the alance sheet. correlate with the market value of assets # as
is often the case with mature industrial companies" %n contrary, some proponents argue
economic profit is Call you needC, it is very risky to depend on an single metric" )he companies
least suited for economic profit are high growth, new economy and high#technology companies,
for whom assets are $off alance sheet$ or intangile"
6ut in overall, we can definitely say that EVAT has emerged as a powerful conceptual
framework and is practically implemented in most of successful corporations across gloe" %t3s
likely to stay as widely accepted concept ecause of its practical application and in depth insights
it throws on performance, efficiency and most importantly how much value has een created to
the shareholders )hus, EVA is oth a measure of value and also a measure of performance" )he
value of a usiness depends on investor3s e0pectations aout the future profits of the enterprise"
/tock prices track EVA far more closely than they track earnings per share or return on e&uity" A
sustained increase in EVA will ring an increase in the market value of the company" As a
performance measure, Economic Value Added forces the organi+ation to make the creation of
shareholder value the numer one priority" 8nder the EVA approach stiff charges are incurred for
the use of capital" EVA focused companies concentrate on improving the net cash return on
invested capital"
'eferences(
9" U1inancial ManagementR %ndian Edition y Eugene 6righam and Micheal Ehrhardt
9=G#99B
B" Pandey % M U1inancial ManagementR Vikas Pulishing 2ouse,PP A;;#AG<
;" @avid / Houng and 1","6yrne /tephen UEVA and Value 6ased ManagementR Mcgraw#
2ill
G" Peter C"6rewer,5yan Chandra, Claton A"2ock, U/am Advanced ManagementR
4ournal,V,F"?G 9:::
>" http(**www"dma"unive"it*mmef*B==A*ModestiVBV9VB==A"pdf#9:
th
/ept B==:
?" http(**www"investopedia"com*terms*e*eva"asp#9>th /ept B==:
A" http(**www"investopedia"com*ask*answers*=?*economicvsmarketv alueadded"asp # 9Gth
/ept B==:
<" http(**www"contractpharma"com*articles*B==G*=9*eva#api# management#practic#9>th /ept
B==: