How do I calculate Economic Value Added (EVA) and how is it different from Market Value Added (MVA)?

Question

I've chosen the Strategic Performance Management and Business Valuation elective for CMA Final. EVA and MVA both talk about creating value. How exactly do I calculate EVA from a profit statement, and what does MVA show that EVA doesn't?

GradeHunt_Team · Answer

EVA asks: did the business earn more than the cost of all the capital it used? Accounting profit ignores the cost of equity, so a company can show a profit and still destroy value.

Formula:
EVA = NOPAT - (WACC x Capital employed)
NOPAT = EBIT x (1 - tax rate). It is the operating profit after tax, before interest, because interest is already part of the WACC charge.

Worked example:
EBIT Rs 150 lakh, tax 25%, capital employed (equity + debt) Rs 800 lakh, WACC 12%.
NOPAT = 150 x 0.75 = Rs 112.5 lakh
Capital charge = 12% x 800 = Rs 96 lakh
EVA = 112.5 - 96 = Rs 16.5 lakh (value created)

Now change only the WACC to 15%:
Capital charge = 15% x 800 = Rs 120 lakh
EVA = 112.5 - 120 = -Rs 7.5 lakh
The profit and loss account looks the same, yet the business now earns less than its investors require.

Points to remember in NOPAT:
1. Don't deduct interest; the tax is on EBIT.
2. Where the question gives adjustments, follow them. The ICMAI study notes add goodwill amortisation and the implied interest on operating leases back to operating profit, and add the present value of operating leases and the accumulated goodwill amortised to capital employed.

Market Value Added:
MVA = current market value of the firm - capital contributed by investors
If the market value of equity and debt is Rs 1,100 lakh and investors put in Rs 800 lakh, MVA = Rs 300 lakh. Positive MVA means the firm has created wealth since it started; negative means it has destroyed wealth.
Some questions use an equity-only version: MVA = market value of equity - book value of equity (net worth). Use the definition the question gives and state it in your answer.

How they differ:
- EVA is a one-period, internal measure from the accounts. MVA is a cumulative, market-based measure.
- In theory, MVA reflects the market's view of all future EVAs, so MVA is roughly the present value of expected EVA.
- MVA moves with share prices, so in a strong bull market it can rise even when management did little. EVA is the better tool for judging one year's performance.

How do I calculate Economic Value Added (EVA) and how is it different from Market Value Added (MVA)?

1 answer