eva final report

Abstract

The performance of a company in financial terms is measured in many traditional measures.

These measures include Net Profit Margin, Operating Profit Margin, Return on Investment

(ROI), Return on Net Worth (RONW), Earning Per Share (EPS) etc. Among these, ROI is

recognized as the most popular yardstick of overall performance. But it is often argued that, in

general, these traditional measures fail to identify the true surplus. Various analysts have given

different reasons behind this. Economic Value Added (EVA) is advocated as a new measure of

corporate performance that focuses on clear surplus in contrast to the traditionally used profit

based indicators. EVA is based on the concept that a successful firm should earn at least its cost

of capital. Firms that earn higher returns than financing costs benefit shareholders and account

for increased shareholder value. For evaluation of the efficiency of any decision, value creation

or value addition aspect is of utmost importance in the present backdrop of corporate

governance. Although adopting a holistic approach safeguarding the interests of all stakeholders

is being emphasized and rightly so, it should be kept in mind that value creation or value addition

aspect is of prime consideration in the assessment of the corporate policy guidelines. If that is not

satisfied, wrong signals will be emitted from securities market and the continuance of the

operations of the entity will be at stake. In view of the above considerations, in the present paper

an attempt has been made to analyze the financial performance of three automobile companies of

India by using EVA.

Introduction

EVA® (Economic Value Added) was developed by a New York Consulting firm, Stern Steward

& Co in 1982 to promote value-maximizing behavior in corporate managers. This term has been

used in the book named “The Quest for Value” which was published in 1991. Stern Steward &

Co claims EVA to be their registered trade mark, while Peter Drucker claimed that he discussed

EVA in 1964 in his book, “Managing for Results”. It cannot be denied; however, without going

into argument as to who invented EVA first that the concept became popular only after Stern

Stewart & Co. marketed it.

EVA is a value-based measure that was intended to evaluate business strategies, capital projects

and to maximize long-term shareholders wealth. Value that has been created or destroyed by the

firm during the period can be measured by comparing profits with the cost of capital used to

produce them. The detailed analysis using EVA may enable the managers to find out activities

which are less profitable, and where the profits are being ‘eaten-up'. EVA, therefore enables the

management to, invest in projects that are critical to shareholder's wealth. This will lead to an

increase in the market value of the company. However, activities that do not increase

shareholders value might be critical to customer's satisfaction or social responsibility. For

example, acquiring expensive technology to ensure that the environment is not polluted might

not be of high value from a shareholder's perspective. Focusing solely on shareholder's wealth

might jeopardize a firm reputation and profitability in the long run.

Researchers have found that managers are more likely to respond to EVA incentives when

making financial, operational and investing decision (Biddle, Gary, Managerial finance 1998),

allowing them to be motivated to behave like owners. However this behavior might lead to some

managers pursuing their own goal and shareholder value at the expense of customer satisfaction.

Unlike traditional methods of performance measurement, EVA focuses on ends and not means.

In other words, we can say that it does not state how manager can increase company's value as

long as the shareholders wealth is maximized.

If we talk about the corporate houses, Cola-Cola is one of the many companies that adopted

EVA for measuring its performance. Its aim, which was to create shareholders wealth, was

announced in its annual report. The EVA calculation show that Coca-Cola's investor received

$8.63 wealth for every dollar they invested.

Mathematically, the EVA can be calculated as

EVA = (NOPAT – WACC) X Capital Employed

Where,

NOPAT means Net Operating Profit before Interest and after Tax

WACC represents Weighted Average Cost of Capital.

Objective:

To study the operational efficiency of the company through the EVA analysis and to understand

how EVA is a useful tool for analysis of a company’s performance.

Literature Review

Baatz (1994) commented that it is but one of many tools being developed to account for the

capital invested in an organization by the true owners of that organization - the shareholders.

Dodd and Chen (1996) explain that EVA is the difference between companies adjusted net

operating profit (after taxes) in a particular year and it total cost of capital.

Rice (1996) indicates there is a growing movement that believes EVA is a tool which can, and

should, be used on an organization-wide basis – particularly in decisions related to the cost

justification of capital equipment. More specifically, we are interested in this paper in how one

organization has used EVA in the capital equipment cost justification process of Advanced

Manufacturing Technology (AMT).

Gompers et al. (2003) examine the relationship between corporate governance and long-term

equity returns, firm value and accounting measures of performance. Their results reveal that

well-governed firms have higher equity returns, command higher values and their accounting

statements show a better operating performance compared to their poorly governed counterparts.

Corporate Governance has a key role to play in the company performance. Investors are

encouraged to consider corporate governance in their investment decisions.

Ali El Mir and Souad Seboui (2008) state that basically the gap created between the

Shareholders’ value and EVA could be better explained by Corporate Governance mechanism.

George Athanassakos (2007) finds that the Value-based management (VBM) is a management

philosophy that uses analytical tools and processes to focus an organization on the single

objective of creating shareholder value. It includes an alignment of corporate strategy,

performance reporting and incentive compensation, and aids to bring all staff together to act like

shareholders, making decisions that maximize value. These decisions should ultimately lead to

improvements in stock market performance over the long run. A good measure of value-based

management is Economic Value added (Value-based management, EVA and stock price

performance.

Lloyd M. Austin (2005), citing ACNZ case adopted EVA as a benchmark to manage firm’s value

and to control its pricing policy. Though, the most accepted valuation methodologies use the Net

Present Value (NPV). But there was no regulation that provides a mandatory calculation method

for the firm’s performance in financial terms. Finally, ACNZ was able to show via the EVA

approach that it was not a monopoly and it was successful in evading price control measure.

Lehn and Makhija (1996:36) conducted a study to find out how well EVA and MVA relate to

share price performance and to see whether Chief Executive Officer (CEO) turnover (the number

of new CEOs during a given period) is related to EVA and MVA. EVA, MVA and CEO

turnover revealed that the CEOs of companies with high EVAs and MVAs had much lower rates

of dismissal than CEOs responsible for low EVAs and MVAs. As expected, a strong inverse

relationship was found between share prices and CEO turnover. The CEO turnover rate for

companies with share returns above the median was EVA and MVA are effective performance

measures that contain information about the quality of strategic decisions and that serve as

signals of strategic change.

Biddle, Bowen and Wallace (1997) say that EVA is more closely associated with equity returns or

firm values than is net income. Two empirical researches were made regarding this. The first

research considers claims regarding the purported superiority of EVA in explaining stock returns

and firm values. The second examines whether managers appear to respond to EVA incentives

when making operating, investing and financing decisions. The work finally establishes that the

comparison between EVA and Earnings according to “Does EVA beat earnings? Evidence on

associations with stock returns and firm values” is not correct and the EVA does not represent actual

profit picture of the firm.

Ahmad Ismail (2006) advocates that after regression analysis of stock return and measures such

as EVA, RI, NI, NOPAT using data from UK companies, came to a conclusion that NI and

NOPAT outperform EVA. EVA model is not able to capture more than 20-24 percent of the

variation in stock return. This leaves 76-80 percent of the variation unexplained. He finally

concludes that there are other non-earnings and non-EVA factors that drive share value and these

should be taken into account either for shareholders’ value.

Research Questions:1) To compare traditional measures ROE, EPS and ROI with EVA & and find ‘whether ROI

and ROE really reflect the value added to shareholders Capital’?

2) For a Company, what does a positive or negative EVA signify, and what does it mean if

the EVA changes sign in a span of years.

Methodology:Three companies (one each from Small, medium and large size with respect to their turnovers in

the automobile sector) have been selected. A comparative study has be done wherein different

financial ratios like leverage ratios, liquidity ratios and cost coverage ratios and others has been

be calculated and interpreted. To evaluate the return on this invested capital, we need an estimate

of the after-tax operating income earned by a firm on these investments. Again, the accounting

measure of operating income has to be adjusted for operating leases, R&D expenses and one-

time charges to compute the return on capital.

Then, EVA has been calculated using the formula:

Economic Value Added = NOPAT – (WACC x CAPITAL EMPLOYED).

NOPAT is calculated as equal to adjusted EBIT(1-T).

ROI = PAT

CAPITAL EMPLOYED

ROE is calculated using Du Pont analysis:

ROE= PAT x Net Sales x Total Asset

Net Sales x Total Asset x Equity

After the calculations, the results thus obtained from the other methods of measurements had

been compared with the EVA analysis of the same companies.

We have calculated the production and other significant expenses as the percentage of net sales.

These values have been used to understand the impact of various expenses on the EVA for the

company.

Data type and years of data:Data from secondary sources like Prowess and Money control.com have been used. Financial

ratios have been calculated using the financial statements procured form the annual reports of the

company. Annual reports of past five years (2004-2008) have been used to consolidate our

study. Some data has been retrieved from BSE websites.

3. Comparisons and Findings

EVA as % of capital employedYear M & M LTD. TATA MOTORS EICHER SWARAJ MAZDA.2004 9.74 -13.94 14.66 49.812005 14.29 -11.41 17.25 34.972006 13.13 12.27 -0.19 8.722007 15.44 15.34 6.98 9.752008 10.09 14.34 5.82 20.01

EXIBIT 1

ROIYear M & M LTD. TATA MOTORS EICHER SWARAJ MAZDA.2004 33.25 7.67 9.10 43.982005 42.56 8.47 16.57 31.102006 42.84 11.41 35.62 9.612007 39.52 12.79 10.22 10.112008 32.34 12.19 9.90 16.24

EXIBIT 2

ROE Calculated using: Du Pont Analysis

Year M & M LTD. TATA MOTORS EICHER SWARAJ MAZDA.2004 28.92 4.62 8.49 11.042005 38.50 5.96 10.23 10.012006 33.83 8.10 28.42 9.682007 34.96 8.68 7.60 8.992008 31.27 7.59 7.23 12.22

EXIBIT 3

Interpretation: TATA MOTORSThe EVA for the year 2004 and 2005 is negative i.e. (633.4) (690.02) which mean its earning

were less than the cost of capital. Also the trends for the ROI and ROE are justified by the

positive trend of EVA.

The EVA in the year 2006 I moving from the negative into a positive territory this is a good

buying signal (Ben McClure investment analyst, McClure & Co).

1 2 3 4 50.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

ROI

1 2 3 4 50.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

ROI

1 2 3 4 5

-20.00

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

EVA AS % OF CE

Interpretation: MAHINDRA &MAHINDRA LTD.The values of the EVA for the consecutive years are decreasing this fluctuating trend indicate inconsistency in operation efficiency. The EVA and ROE trend is positive but investing based on the trend of ROI can mislead the investing decision. Further the trend of EVA is increasing but the increase is less significant as in case of TATA MOTORS.

Hence if we compare TATA MOTORS and MAHINDRA &MAHINDRA Ltd. then the EVA indicators suggest the TATA MOTORS is winner in terms that it adds economic values (EVA as percentage of capital employed of TATA MOTORS and MAHINDRA &MAHINDRA Ltd are 10.03% and 14.33% respectively)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

M & M Ltd.

ROI

1 2 3 4 50.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00M & M Ltd.

ROE

1 2 3 4 50.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

M & M Ltd. EVA AS % OF CE

Interpretation: SWARAJ MAZDAThe EVA trend is negative, but when the figures from the year 2006 to 2008 is considered the

trend is positive in case EVA, ROI, ROE which mean its operational; efficiency is increasing

1 2 3 4 50.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00SWARAJ MAZDA

ROI

1 2 3 4 50.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00SWARAJ MAZDA

ROE

1 2 3 4 50.00

10.00

20.00

30.00

40.00

50.00

60.00

SWARAJ MAZDA

EVA

Interpretation: EICHER MOTORS

First when we look at the figures of ROI and ROE for the year 2006, there overwhelming returns

can mislead the investing decision, but the EVA here tell the true story for EICHER motors and

reports a negative figure of (1.71) Cr. The reason for the sudden increase in the returns was due

to the sale of Fixed assets by the company in that year for Rs 173 Cr and this is not taken into

the adjusted EDBIT for calculation of NOPAT for EVA calculation which indicated the true

economic value added by the company. Also the trend for EVA, ROI and ROE is negative which

indicate that the company is underperforming.

Hence when we compare SWARAJ MAZDA and EICHER MOTORS performance based on EVA indicators (EVA as percentage of capital employed for SWARAJ MAZDA and EICHER MOTORS was 20.01% and 5.81%)

1 2 3 4 50.00

2.00

4.00

6.00

8.00

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12.00

14.00

16.00

18.00EICHER MOTORS

ROE

1 2 3 4 50.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00EICHER MOTORS

ROI

1 2 3 4 5

-5.00

0.00

5.00

10.00

15.00

20.00

EICHER MOTORS

Eicher Vs Swaraj Mazda

Eicher Motors

2004 2005 2006 2007 2008Net Sales 1372 1995.77 1649.38 1968.64 2218.83

Raw Materials 970.88 1509.68 1279.89 1445.53 1672.08

%70.76385

75.64399

77.59825

73.42785

75.35863

Power & Fuel cost 15.07 17.56 13.19 14.86 15.88

%1.098397

0.879861

0.799694

0.754836

0.715693

Employee Cost 90.18 104.5 93.36 103.09 128.47

%6.572886

5.236074

5.660309 5.23661

5.789988

Selling & Admin exp 158.93 206.47 210.11 258.17 296.4

%11.58382

10.34538

12.73873

13.11413

13.35839

PAT 33.62 58.85 216.88 61.26 63.05

%2.450437

2.948737

13.14918

3.111793

2.841588

Swaraj Mazda

2004 2005 2006 2007 2008Net Sales 478.02 589.62 611.82 601.34 669.57

Raw Materials 371.56 480.85 522.35 506.17 565.55

%77.72897

81.55253

85.37642

84.17368

84.46466

Power & Fuel cost 2.24 3.77 3.97 3.76 3.55

% 0.46860.639395

0.648884 0.62527

0.530191

Employee Cost 19.25 20.39 22.27 26.68 29.14

%4.027028

3.458159

3.639959

4.436758

4.352047

Selling & Admin exp 43.87 41.67 34.52 31.82 32.4

% 9.177447.067264

5.642182

5.291516

4.838926

PAT 21 24.25 16.78 16.09 25.2

%4.393122

4.112818

2.742637

2.675691

3.763609

2004 2005 2006 2007 20080

10

20

30

40

50

60

70

80

90

Raw Materials as a % of Sales

Eicher Motors Swaraj Mazda

%

2004 2005 2006 2007 20080

0.2

0.4

0.6

0.8

1

1.2

Power & Fuel Cost as a % of Sales


%

2004 2005 2006 2007 20080

1

2

3

4

5

6

7

Employee Cost as a % of Sales


%

2004 2005 2006 2007 20080

2

4

6

8

10

12

14

16



Axis Title

2004 2005 2006 2007 20080

2

4

6

8

10

12

14

PAT as a % of Sales


%

Tata Motors vs Mahindra Automotives

Tata Motors 2004 2005 2006 2007 2008Net Sales 13028.17 17199.17 20088.63 26664.25 28738.3 Raw Materials 8578.12 12245.28 14633.02 19879.56 20891.33% 65.84286 71.19692 72.8423 74.55511 72.69508Power & Fuel cost 214.52 237.81 258.51 327.41 325.19% 1.646586 1.382683 1.286847 1.227899 1.131556Employee Cost 882.49 1039.34 1143.13 1367.83 1544.57% 6.773707 6.042966 5.690433 5.129827 5.374605Selling & Admin exp 685.01 890.21 1061.07 1505.23 2197.49% 5.257914 5.175889 5.281943 5.645124 7.646555PAT 810.34 1236.95 1528.88 1913.46 2028.92% 6.219907 7.191917 7.610673 7.176125 7.059986

Mahindra & Mahindra 2004 2005 2006 2007 2008Net Sales 4931.67 6594.69 8136.59 9921.34 11310.37 Raw Materials 3417.52 4829.29 5885.21 6937.16 7963.82% 69.29742 73.22998 72.33018 69.9216 70.41167Power & Fuel cost 45.64 52.64 57.46 65.19 91.33% 0.925447 0.798218 0.706193 0.657069 0.807489Employee Cost 417.45 464.25 551.78 666.15 853.65% 8.464678 7.039755 6.781465 6.714315 7.547498Selling & Admin exp 431.03 545.57 667.99 891.29 1108.33% 8.740041 8.272868 8.209705 8.983565 9.799237PAT 348.54 512.67 857.1 1068.39 1103.37% 7.067383 7.773982 10.5339 10.76861 9.755384

04 05 06 07 0860

62

64

66

68

70

72

74

76

Raw Material as a % of Sales

Tata Motors Mahindra & Mahindra

%

04 05 06 07 080

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

Power & FUel Cost as a % of Sales


%

04 05 06 07 080

1

2

3

4

5

6

7

8

9



%

04 05 06 07 080

2

4

6

8

10

12

Selling & Admin Expenses as a % of Sales


%

04 05 06 07 080

2

4

6

8

10

12

PAT as a % of Sales


%

Application of EVA in the industry:1) Make better investment decisions:

The management can use the EVA for accessing the performance of the business units or

segments within the company. If the segment is making surplus after achieving the cost of capital

then it makes sense to invest into it.

2) It helps in designing compensation system for managers based on EVA.

3) It brings goal congruence or matching of employees and shareholders It provides significant

information beyond traditional accounting measures like ROI, ROCE, EPS etc

Conclusion:

EVA is superior to conventional measures because it replicates the discipline of the capital

markets within the firm by explicitly measuring Return on Capital Employed (ROCE) relative to

the cost of equity.

eva final report

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