economic value added

Session XIII

Economic Value Added

INCENTIVES & PERFORMANCE MEASUREMENT-SPRING 2007 2

Economic Value-added Analysis

EVA® Measurement Alternative for Shareholder

Value Elements


A Little Bit of History Residual income measures have been around for over

100 years in academic literature. Stern Stewart & Co. introduced the formal concept of

EVA® about 10 years ago. Fortune Magazine put EVA® on the map in a September

1993 article. A whole slew of offspring have followed.

SVA from Andersen Consulting Other variations of Economic Value Added

Some testimonials


EVA™ Testimonials

“Only EVA® gives a real picture of value creation. Accounting benchmarks just don’t do the job.” Robert Boldt, Calpers.

EVA® correlates better with stock performance than EPS. Fortune Magazine study.


EVA® Benefits

Objective evaluation Easy tool for strategic decision support Common shareholder & management focus Consistent measurement tool Improves on-going operating decisions Provides basis for common incentive-pay


EVA® Risks

May be subjective in implementation. Singular reliance on EVA® may be misleading.


Let’s Define EVA®

When the Cost of Capital is less thanthe Operating Income from that Capital, you create EVA®!!!

Sources of Capital-Debt-Equity

“Stuff” Generates Income

Capital Buys “Stuff”


EVA® Elements Cost of Debt Financing Cost of Equity Financing Components of Capital Adjusted Net Operating Income


Cost of Debt Financing

Interest Expense After-tax Impact Consider all Debt, Excluding A/P


Cost of Equity Financing

Shareholder Hurdle Rate Price Appreciation Dividend Rate “Six Percentage Point” Rule


Components of Capital Net Working Capital Net Long-lived Tangible Assets R & D Spending Employee Development Spending


Adjusted Net Operating Income

Substitute R&D and Employee Development Costs with Annual Amort.

Use Net Income from Continuing Operations Adj. Net Op. Income Minus Cost of

Financing Equals Economic Value Added


EVA® Uses

Planning Tool Business Unit Evaluation Incentive Compensation Base Merger and Acquisition Analysis Capital Asset Analysis


Corporate Examples

CSX Quaker Oats


Ways to Raise EVA® Increase Profits Reduce Capital Spending Reduce Investment in Working Capital Increase High-margin Capital Investments


EVA® Implementation

Top management buy-in Make it a way of life Implement Gradually Keep it Simple Train the users


Market Value Added--MVA®

…another Measure of Wealth

A second Stern Stewart concept Compares Borrowed, Invested and Earned

Capital versus Current Market Value of Debt and Equity A Prospective Stream of Future EVA®

economic value added

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