Economic Value Added

Economic Value Added computes the value created or destroyed each year by deducting a charge for capital from the NOPAT of the companies. Thus

 EVA = NOPAT - Capital Charge (Capital * CoC)

 The biggest advantage or strength of EVA lies in the fact that it makes certain adjustments to arrive at NOPAT. It takes into account the differences on account of off balance sheet items, interest expenditure, Research & Development expenditure, etc. to arrive at NOPAT. Thus it accounts for the differences in the accounting profits and enables a better comparison between two firms.

EVA is the excess or loss of profit over cost of capital. In other words if a firm has invested 1000 rupees and expected rate of return is 10% per annum, then this investment can create value for the firm when the profit generated for a year exceeds 100 rupees. Therefore it is superior in measuring value creation to a firm vis-à-vis conventional costing parameters like RONW, ROTA, ROCE, etc as these measures can give a positive figure for profitability for the firm, while the EVA is negative at a profit of 90 rupees for the year.

 Examples:

Godrej Consumer Products Limited (GCPL) has been successful in completing an EVA implementation program during the year. EVA (Economic Value Added) is a measure of shareholder value and is the value added by the company for its investors by generating profits in excess of the cost of capital employed by the company.

The EVA Framework implementation at GCPL was facilitated by Stern Stewart & Company, the New York based management consulting firm that pioneered the development of the EVA Framework.

Apart from being a company level performance measure, EVA has been adopted as a management process, as well as, a motivation driver for employees. The former involves integrating value based thinking into all management processes and developing relevant tools and frameworks to guide management in their strategic, operating and financing decisions to improve their businesses’ EVA. The latter is achieved through the EVA based performance linked variable remuneration (PLVR) scheme, which directly links remuneration of employees to the value added to the shareholder’s funds by the company.

GCPL has been able to create a positive EVA of Rs. 30.1 crore during the year 2001-02.

Godrej is amongst the handful of leading Indian adopters of the EVA Framework. Other Indian companies who have adopted EVA are TCS and NIIT. Internationally such shareholder value based management approaches have been adopted very widely, including prominent MNCs such as Coca Cola, Bausch & Lomb, Cadbury, Diageo, Hershey Foods, Johnson & Johnson, Kao Corp, Quaker Oats, Siemens, Sony, Whirlpool and Unilever.

Many influential investors and independent experts have endorsed the EVA management system. A number of empirical studies have shown that companies that have successfully adopted the EVA Framework have significantly out-performed peers in creating superior returns to shareholders

Tata Steel

Tata Steel's EVA for 2001 stood at a negative Rs 552 crore against a negative Rs 778 crore recorded in 2000. Its ROCE for 2001 was placed at 9 per cent, while the cost of capital was calculated at 12.7 per cent.

Marico

The EVA and ROCE comparison can be shown below:

It is observed that EVA return is much lower as compared to ROCE.

HLL

Hindustan Lever Limited has defined EVA as residual income after charging the company for the cost of capital provided by lenders and shareholders. It represents the value added to the shareholders by generating operating profits in excess of the cost of capital employed in the business as shown below:

It had a ROCE of 67% in the year 1999.  

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