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Hello Grommit,
In EVA , capital employed is taken at the start of the year or at the year end?
In most of the examples closing Capital employed (adjusted) of the previous year is used. Why dowe take the opening figure, why not the closing adjusted figure of the current year?Thanks in advance.
Hello Grommit.
In EVA you use the capital figure at the beginning of the period for the calculation of the capital charge i.e. you have to multiply WACC * net assets at the start of the period. I guess (I am not very sure) you use the figure at the beginning of the period because it would not make sense to use the closing figure for the charge as you have not been using the closing figure investment for the entire year.
AmarainActually, I’m not completely sure why the opening capital employed is used rather than at year end! EVA is a method of analysis that was developed and defined by a firm of consultants called Stern Stewart. They defined the capital employed as the opening balance. Best to go with the flow and to use that. Opening capital is what the examiner expects.
IT IS ASSUMED THAT THE CAPITAL AT THE START OF THE YEAR IS THE ONE THAT WAS USED TO GENERATE THE PROFITS AT THE END OF THE YEAR .THEREFORE THATS THE REASON WHY WE USE CE AT THE BEGINNING OF THE YEAR AND NOT END OF YEAR .
Obviously that is the assumption, but an equally valid one would be to take the average of opening and closing capital.
I was solving an example in OT notes [chapter 10 examplw #5] related to EVA, i figured out that the non cash expenses and economic dep have not been treated in 2006 C.E in order to calculate Opening C.E for 2007.
Although its not valid for 2006 Opening C.E. but Why has this not been treated in 2007?Please clarify.
We are trying to relate the ‘cash’ profit to the ‘true’ value of the net assets.
You are obviously OK with the cash profits. As regard the net assets, the only normally significant part are the non-current assets, so we add non-capitalised leases, R&D etc., and replace the accounting depreciation with the economic depreciation. However since the latter is messy, in the exam questions they say that the accounting and economic depreciations are the same.
You are correct about the non-cash expense and I think it should be added back to capital. See Q3 Dec 12 P5 exam and answer, Stillwater Services.
Thanks
You just reminded me of this question, here i want to know about the RND expense of $12 which we has been added back in Profits.
The charge for 2012 of this RND’s economic dep over 5 years is not included. Where as, in Nick Ryan’s article on EVA this kind of adjustment has been made in an example. would it be wrong to charge 12 / 5= 2.4 in p/L?Adding back R&D is a standard adjustment because it is regarded as an investment not a cost. (No need to adjust openinf capital as no R&D in the prior year).
Book depreciation in the P&L is replaced with economic depreciation (no need to adjust capital because in previous years it’s stated these were the same).
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