Value Added: Market Value Added and Economic Value Added

VALUE ADDED

• MARKET VALUE ADDED
• ECONOMIC VALUE ADDED

MARKET VALUE ADDED (MVA)

Market value added (MVA) 

= Current market value or capitalisation (to which debt may be added) – Total shareholders’ equity  

Example:

Capitalisation of a company is $100

Shareholders’ equity in balance sheet is $50

For every $1 of shareholders’ equity, the company has added $1.

ECONOMIC VALUE ADDED (EVA)

Companies should be expected to produce not only an accounting profit but also one that more than covers their cost of capital.

It is argued that EVA is better than earnings per share or price/earnings ratios as these do not take account of the real cost of capital.

Example:

After the charge of $10 ($100 x 10%) representing the estimated cost of capital, the company shows an EVA of $30 for the period.

After tax profit $40

Capital Employed $100

Cost of Capital 10%

After tax profit $40

Cost of Capital $10

ECONOMIC VALUE ADDED $30

A positive EVA indicates that a company is providing investors with added value.

A company with a consistent EVA should have an increasing MVA; it will be generating a rate of return above the cost of capital so the share price should rise.

Examples:

These three companies are all generating a positive return on capital employed.

Company A

After-tax profit $50

Capital employed $200

Cost of capital (10%) $20

ROCE (%)  25

EVA ($)  $30

Company B

After-tax profit $60

Capital employed $400

Cost of capital (10%) $40

ROCE (%)  15

EVA ($)  $20

Company C

After-tax profit $50

Capital employed $600

Cost of capital (10%) $60

ROCE (%)  8

EVA ($)  -10

Although company C produces a positive 8% return on capital employed, it is actually destroying shareholder value with a negative $10 EVA.

In practice, the calculation of EVA requires several adjustments – to allow for the treatment of R&D, goodwill, and brand values, leases and depreciation – to be made to the after-tax profit figure.

It is claimed that EVA, as a single monetary figure, is better at concentrating management attention on the “real” results of running the business than are standard performance ratios such as ROTA.

EVA is often used as a basis for managers’ performance-related incentives.