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Introduction of EVA
EVA was developed by a New York consulting firm, Stern Steward & Co. in 1982 to promote value-maximisig behaviour in corporate managers. Value-based measure to evaluate business strategies, capital projects and to maximise long-term shareholders wealth. EVA sets managerial performance target and links it to reward systems. Unlike simple traditional budgeting. EVA focuses on ends and not means.
Taxes
Cost of capital
Selling, general & Admin 4,00,000/00,000/ Exp. Exp. (-) Operating Profit Taxes (-) NOPAT 3,36,000/36,000/ 1,34,000/34,000/ 2,02,000/02,000/
Cost of Capital
Meaning: Meaning: The cost of capital is the rate of return required by the shareholders and lenders to finance the operations of the business. Types of Cost of Capital Equity Capital: Equity Capital is provided by the Shareholders. Capital: Borrowed Capital: It is the Capital borrowed by the company Capital: from Banks and other Financial Institutes.
WACC Continue
WACC Continue
Preference Share (Per share) Net Revenue (Deducting discount & financing cost) Dividend Cost for Preferred Share
(11/98 x 100)
WACC Continue
(Per Share)
Net Return (Less issuing cost) EPS (Estimated by investors & reliable analyst) Cost for Common Equity
(12/85 x 100)
WACC Continue
Summarizing
The total Weighted Average Cost of Capital (WACC) = 1,68,478 / 14,00,000 = 12.03% 68, 14,00, 12.03%
Advantages of EVA
EVA provides for better assessment of decisions that affect balance sheet and income statement or tradeoffs between each through the use of the capital charge against NOPAT. EVA decouples bonus plans from budgetary targets. EVA covers all aspects of the business cycle. EVA aligns and speeds decision making, and enhances communication and teamwork.
Limitations of EVA
EVA does not control for size differences across plants or divisions. EVA is based on financial accounting methods that can be manipulated by managers . EVA may focus on immediate results which diminishes innovation. EVA provides information that is obvious but offers no solutions in much the same way as historical financial statement do.
Conclusion
As a performance measure, Economic Value Added forces the organization to make the creation of shareholder value the number one priority. EVA is changing the way managers run their businesses. When business decisions are aligned with the interest of the shareholders, it is only a matter of time before these efforts are reflected in a higher stock price.