Economic Value Added (EVA), Market Value Added (MVA)

Economic Value Added (EVA)

Economic Value Added (EVA) is a financial metric that measures the value created by a company above its cost of capital. It was developed by Stern Stewart & Co, a consulting firm, in the late 1980s as a way to help companies measure and improve their financial performance.

EVA is based on the idea that a company’s ultimate goal is to create value for its shareholders, and that value creation can be measured by the difference between the return on invested capital (ROIC) and the cost of that capital. In other words, if a company is generating returns that are higher than its cost of capital, it is creating value for its shareholders, and if it is generating returns that are lower than its cost of capital, it is destroying value.

The formula for calculating EVA is as follows:

EVA = Net Operating Profit After Tax (NOPAT) – (Cost of Capital x Total Invested Capital)

Where

NOPAT is the company’s after-tax operating income and

Total Invested Capital is the total amount of capital invested in the business, including both debt and equity.

By using EVA as a performance metric, companies can identify areas where they can improve their financial performance. For example, if a company’s EVA is negative, it may need to improve its operational efficiency, reduce its capital expenditures, or restructure its debt in order to increase its returns and create value for its shareholders.

Economic Value Added (EVA) Steps

The steps involved in calculating Economic Value Added (EVA) are as follows:

• Determine the company’s Net Operating Profit After Tax (NOPAT): This is the company’s operating income after taxes and is calculated by subtracting all operating expenses, including taxes, from total operating revenues.
• Calculate the cost of capital: This is the minimum rate of return that investors require to invest in the company. It is typically calculated by using the weighted average cost of capital (WACC), which takes into account the cost of both debt and equity.
• Determine the total amount of invested capital: This includes all capital invested in the business, including both debt and equity. It is calculated by adding the market value of the company’s equity to its debt.
• Subtract the cost of capital from NOPAT: This gives you the company’s Economic Value Added (EVA). If the EVA is positive, the company is generating value for its shareholders. If it is negative, the company is destroying value.
• Analyze the results: Once you have calculated the EVA, you can use it to identify areas where the company can improve its financial performance. For example, if the EVA is negative, the company may need to reduce its capital expenditures, improve its operational efficiency, or restructure its debt in order to increase its returns and create value for its shareholders.

Types

There are two types of Economic Value Added (EVA):

Accounting EVA:

The formula for Accounting EVA is as follows:

EVA = Net Operating Profit After Taxes (NOPAT) – (Total Cost of Capital x Total Capital Invested)

Where NOPAT is the company’s operating income after taxes, and the total cost of capital is the weighted average of the cost of debt and the cost of equity, and the total capital invested is the sum of debt and equity.

Economic EVA:

The formula for Economic EVA is as follows:

EVA = Net Operating Profit After Taxes (NOPAT) – (Capital Charge)

Where NOPAT is the same as in Accounting EVA, and the Capital Charge is the amount of capital the company has used to generate its earnings, multiplied by the cost of capital.

Advantages of Economic Value Added (EVA):

• Focus on long-term profitability: EVA encourages managers to focus on long-term profitability rather than short-term gains, which can lead to sustainable growth.
• Aligns interests of shareholders and management: EVA aligns the interests of shareholders and management by tying compensation to the creation of value for shareholders.
• Helps identify areas for improvement: EVA can help identify areas where a company is not generating sufficient returns, and provide guidance on where resources can be allocated to improve financial performance.
• Considers the cost of capital: EVA takes into account the cost of capital, which can help avoid investments that may generate profits but do not generate a return on capital that exceeds the cost of capital.
• Easy to understand: EVA is a simple and easy-to-understand metric that can be used to compare the financial performance of different companies.

Disadvantages of Economic Value Added (EVA):

• Difficult to calculate: EVA is more complex to calculate than other financial metrics, and requires a significant amount of financial analysis.
• Requires accurate financial data: EVA requires accurate financial data, which can be difficult to obtain, particularly for small companies.
• May not be suitable for all companies: EVA may not be suitable for companies with low margins or high levels of debt, as it may not accurately reflect their financial performance.
• Can be subjective: EVA can be subjective, as it relies on management’s estimates of future cash flows and the cost of capital.
• May be affected by accounting policies: EVA may be affected by the company’s accounting policies, which can impact the calculation of NOPAT and invested capital.

Market Value Added (MVA)

Market Value Added (MVA) is a financial metric that measures the difference between the current market value of a company and the amount of capital that has been invested in it. MVA is an extension of the concept of Economic Value Added (EVA) and is used to determine the value that a company has created for its shareholders.

The formula for Market Value Added (MVA) is as follows:

MVA = Market Value of Equity – Total Capital Invested

Where the market value of equity is the current market price per share multiplied by the number of outstanding shares, and the total capital invested is the sum of debt and equity.

MVA represents the value that a company has created for its shareholders over its lifetime, and can be used as a measure of long-term financial performance. A positive MVA indicates that the company has created value for shareholders, while a negative MVA indicates that the company has destroyed value.

MVA is a useful metric for companies that have been operating for a significant amount of time, as it takes into account the total amount of capital that has been invested in the company since its inception. However, it is less useful for newer companies or companies that are undergoing significant changes in their capital structure, as it may not accurately reflect the value created by these changes.

Market Value Added (MVA) Steps

The steps to calculate Market Value Added (MVA) are as follows:

• Determine the current market price per share of the company.
• Determine the number of outstanding shares of the company.
• Multiply the current market price per share by the number of outstanding shares to calculate the market value of equity.
• Determine the total amount of capital that has been invested in the company, including debt and equity.
• Subtract the total amount of capital invested from the market value of equity to calculate the MVA.
• Analyze the MVA to determine whether the company has created or destroyed value for shareholders. A positive MVA indicates that the company has created value, while a negative MVA indicates that the company has destroyed value.
• Compare the MVA of the company to those of its peers to determine its relative performance.

Advantages of Market Value Added (MVA):

• Focuses on long-term value creation: MVA measures the value that a company has created for its shareholders over the long term, providing insight into the company’s ability to create value beyond short-term profits.
• Incorporates market expectations: MVA takes into account the market’s expectations of a company’s future performance, reflecting the market’s assessment of the company’s growth prospects.
• Provides a comprehensive view of value: MVA considers both equity and debt capital, providing a comprehensive view of the total value created by the company for all investors.
• Facilitates comparisons between companies: MVA can be used to compare the relative performance of companies in the same industry, providing insight into which companies are creating the most value for their shareholders.

Disadvantages of Market Value Added (MVA):

• Can be affected by external factors: MVA can be influenced by external factors such as changes in interest rates or economic conditions, which may not necessarily be within the control of the company.
• Limited to publicly traded companies: MVA can only be calculated for publicly traded companies, as the market value of equity is based on the current market price per share.
• May not capture short-term value creation: MVA is focused on long-term value creation and may not capture the short-term value that a company creates through profits or cash flow.
• Does not consider non-financial factors: MVA does not take into account non-financial factors such as corporate social responsibility or environmental impact, which may be important considerations for some investors.

Differences between Economic Value Added (EVA) and Market Value Added (MVA)