Professional Documents
Culture Documents
Dr Sarbesh Mishra
Finance Area, NICMAR, Hyderabad.
Backdrop If we don t know where were going, it doesnt matter how we get there (Attitude = 100%)
Recent Buzzword in Industry:
3.
4. 5.
Too much of power with few individual. Large scale diversion of funds to associated companies & risky ventures. Unfocussed business decisions leading to losses. Preferential allotment of sweat equity at low prices. Spinning off profitable business operations to subsidiary companies.
Recent Happenings
World Com Improper accounting of $3.9bn in expenses leading to bankruptcy. Enron Off balance sheet deals used to hide the debt. AOL Warner AOL division accused of improperly accounted for some advertising revenues. XEROX Financial Fraud. UTI Indiscriminate investment by UTI.
Origin
The Sarbanes Oxley Act, 2002, a recent enactment in USA which deals with the Corporate Governance & Corporate Social Responsibilities has emphasized audit functions & financial disclosures. (Mandatory as per NYSE listing Norms)
(Benchmark practices in this regard is calculation of EVA apart from Annual Accounts)
Indian Context
Kumara Mangalam Birla Committee on Corporate Governance (2000) (SEBI Sponsored) Naresh Chandra Committee on Corporate Governance (2002) Narayana Murthy Committee on Corporate Governance
What is EVA?
New York based financial advisory Stern Stewart & Co. postulated the very concept of Economic Value Added (EVA) in 1990.
EVA: Maximum amount which the business is capable of distributing to its shareholders while remaining in the same position at the end of the period as it was at the beginning with fair practices.
EVA Formula
EVA = NOPAT - Cost of Capital
NOPAT = Net operating Profit after Tax 2. The projects cost of capital is the minimum required rate of return on funds committed to the project, which depends on the riskiness of its cash flows. The firms cost of capital will be the overall (WACC), or average, required rate of return on the aggregate of investment projects.
1.
Summary of Definition
Thus
EVA measures the Operating Profit, which should be fair enough to meet the cost of capital. So excess of returns over cost of capital is otherwise referred as EVA.
If EVA is +Ve = Firm is creating shareholders wealth -Ve = Firm is destroying shareholders wealth
Computation of NOPAT
Profit after tax but before Interest + Increase to Deferred Taxes + Goodwill Amortized in Current year + Increase to Net Capitalized Intangibles +/- Unusual loss or (Gains) net of tax
N. B: Some 144 adjustments are there
Implementation of EVA
Measurement Management
System
Motivation
Mindset
= (5,500cr+1,000cr) - WACC 1/2(Capital at the beginning of the year + Capital at the end of the year)
Workings
WACC = Ke* W1 +Kd* W2
Debt : Equity
= 0.14 * 0.7 + 0.8(1- Tax) * 0.3 30 : 70 = 0.98 + 0.3 * (0.8 * 0.65) W2 : W1 = 0.98 + 0.3 * 0.52 Ke = 14% as per govt. norms = 0.098 + 0.15 Kd = Int. paid/Loan Taken = 0. 254 Tax= 35%
Ke
= 0.08 + 0.8 (0.14 0.08 ) Rm = Market Rate of Return = 0.08 + 0.8 * 0.06 B = Beta Coefficient for NTPC
= 0.134
B = Covariance of Rm & Rf
Variance of Rm
EVA of NTPC
EVA Deficiency
Not easy to use (for calculation of PAT, some 144 adjustments are there) too complicated for small business. Recommends inexpensive debts in order to reduce cost of capital (COC), is a very questionable strategy for small business. A passive accounting tool : measures past performance.
Inference
Thus, A company must strive continuously to increase not only profitability but also the EVA. EVA reflects high net worth of the company, thus its credibility increases. In India, Companies like Dr. Reddys Lab, WIPRO, INFOSYS are coming up with their respective EVAs along with their Annual Report.