Economic Value Added

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Session XIII

• Economic Value Added

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Economic Value-added AnalysisEVA

• Measurement Alternative for Shareholder Value
• Elements

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A Little Bit of History

• Residual income measures have been around for
  over 100 years in academic literature.
• Stern Stewart Co. introduced the formal concept
  of EVA about 10 years ago.
• Fortune Magazine put EVA on the map in a
  September 1993 article.
• A whole slew of offspring have followed.
• SVA from Andersen Consulting
• Other variations of Economic Value Added
• Some testimonials

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EVA Testimonials

• Only EVA gives a real picture of value
  creation. Accounting benchmarks just dont do
  the job. Robert Boldt, Calpers.
• EVA correlates better with stock performance
  than EPS. Fortune Magazine study.

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EVA Benefits

• Objective evaluation
• Easy tool for strategic decision support
• Common shareholder management focus
• Consistent measurement tool
• Improves on-going operating decisions
• Provides basis for common incentive-pay

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EVA Risks

• May be subjective in implementation.
• Singular reliance on EVA may be misleading.

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Lets Define EVA
When the Cost of Capital is less than the
Operating Income from that Capital, you create
EVA!!!
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EVA Elements

• Cost of Debt Financing
• Cost of Equity Financing
• Components of Capital
• Adjusted Net Operating Income

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Cost of Debt Financing

• Interest Expense
• After-tax Impact
• Consider all Debt, Excluding A/P

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Cost of Equity Financing

• Shareholder Hurdle Rate
• Price Appreciation
• Dividend Rate
• Six Percentage Point Rule

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Components of Capital

• Net Working Capital
• Net Long-lived Tangible Assets
• R D Spending
• Employee Development Spending

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Adjusted Net Operating Income

• Substitute RD and Employee Development Costs
  with Annual Amort.
• Use Net Income from Continuing Operations
• Adj. Net Op. Income Minus Cost of Financing
  Equals Economic Value Added

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EVA Uses

• Planning Tool
• Business Unit Evaluation
• Incentive Compensation Base
• Merger and Acquisition Analysis
• Capital Asset Analysis

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Corporate Examples

• CSX
• Quaker Oats

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Ways to Raise EVA

• Increase Profits
• Reduce Capital Spending
• Reduce Investment in Working Capital
• Increase High-margin Capital Investments

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EVA Implementation

• Top management buy-in
• Make it a way of life
• Implement Gradually
• Keep it Simple
• Train the users

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Market Value Added--MVAanother Measure of
Wealth

• A second Stern Stewart concept
• Compares Borrowed, Invested and Earned Capital
  versus
• Current Market Value of Debt and Equity
• A Prospective Stream of Future EVA