Economic value added (EVA) is a performance metric that is very similar in approach to Residual
Income, and is defined as being:
EVA = Net operating profit after tax – WACC x book value of capital employed
EVA is a trade-marked technique, developed by consultants called Stern Stewart and Co.
The principle behind it is that a business is only really creating value if its profit is in excess of the required minimum rate of return that shareholders and debt holders could get by investing in other securities of comparable risk.
The capital employed is the opening capital employed, adjusted fro the items set out below.
EVA allows all management decisions to be modelled, monitored, communicated, and compensated in a single and consistent way – always in terms of the value added to shareholder investment.
However, EVA makes certain adjustments because certain types of expenditure which appear in the statements of profit and loss under ISAs and IFRSs are NOT regarded as expenses when using EVA and cash accounting is regarded as more reliable than accruals accounting).
Sir why post tax interest expense is not added back in capital employed as well?
The capital employed is the opening capital employed so the current year’s interest is not relevant to that.
Dear Sir,
I have two questions relating to this lecture video.
1. @ 12:32: I can see non-cash expenses are added back to net profit after tax. So effectively, we do not adjust for tax @ 25%. Why is this not added back to profit before tax where tax will have impact (ie, 100*[1-30%] positive EVA adjustment) similar to interest?
2. @ 24:24: The opening 2014 CE did not adjust for interest payable of 2013. From my understanding capital employed = Net assets – current liabilities (which would have included this amount). Please advise why this would not have been deducted from OP CE?
Thanks.
Hi sir,
I got the same question regarding @ 12:32, should we also consider the tax effects of the non-cash expenses we add back?
Thank you!!
Hi,
Aren’t EVA calculation impacted by the recent launch of IFRS16 and showing all operating leases as part of assets/liabilities? Or it’s not yet covered for the March’20 syllabus and we should focus on the “old” way?
Hi,
When calculating the WACC for the pre tax (1-0.3) – can you explain why we do this part as I don’t exactly follow it?
Thanks
Do you mean the calculation at about 29:20?
70% x 15% + 30% x 9%(1-0.3)
9% is the pre-tax cost of debt (per question). Debt interest enjoys tax relief at the corporation tax rate (here 30%) so this effectively reduces the cost of debt by 30% to 9%(1 – 0.3).
Dear sir, i am a bit confused with the question Metis Restaurant, where in part b for the EVA, in the answer given the NOPAT is added with the capital charge to reach an EVA of 108625
Is this correct?
Hello,
If this could answer to your question:
EVA™ = NOPAT – Capital employed x WACC
NOPAT= 262322*(1-0.3)= 183626
WACC= 12.5%*600000= 75000
EVA=183,626-75000=108626
Hi Sir,
Can you confirm as to why the research and development expenditure written off of $10M in 2013 was added back to find capital employed in 2014?
I tried finding NOPAT on the 2nd EVA question using the other method but im not able to get the same amounts. Can you provide a solution for that scenario?
I am working June 2011 JHK Coffee Machines. For EVA computation profit before head office expenses were used. Is this standard? When u was working it I had used after head office expense because controllable profit is adjusted for under RI. Kindly assist
hi,
I’m struggling figure out how calculated wacc for June 2014 where they got 1/1,3 and .3/1,3. It’s same in question in September/ December 2015 how did they get figures for wacc.
Dear Sir
Thank you for the lessons, as recommended from your lecture to try to practice a question on EVA ( Jun 14 Cantor ), i got stuck on the EVA question.
Wacc was calculated as
= (1/1.3 * 15.7) + (0.3/1.3 * 6.5% * (1-25%))
I would like to know where the 1/1.3 and 0.3/1.3 came from please.
Thank you
The treatment of the non-capitalised leases was rather confusing. I would have thought that because they were not capitalised, they would also be added back to the PAT in 2013 and 2014. I would appreciate a clarification. Thanks
These leases were valued at $16m in each year and were not amortised. Therefore, they have no impact on PAT, only the net assets.
Key: “not amortised”. I understand now. Thanks
brilliant lecture-thanks.
it was not clear regarding the adding back of expenses charged in a prior year when doing the current year C.E-but the simple example you replied to sehdevadesh made life easier.
Thanks very much for your very helpful lectures.
Two questions:
1) why do we use target gearing instead of actual gearing when calculating WAC?
2) in this example we don’t have non cash item details to adjust capital at beginning of first year, so we assume it to be nil. If they had given us this value, and we therefore adjust year one’s opening capital, for year two’s opening capital do we then adjust for all of the preceding years’ non cash charges cumulatively?
Thanks again!
Hi
I am a bit confused with Capital employed? I have a quick question: if CE is taken at the beginning of the year, when we are adding back written off goodwill, r&D and provisions, – are these provision from the prior year? otherwise if it is from current year adding to CE at the beginning of the year – it becomes double counting or?
thank you so much for clarifying
Hi
I am a bit confused so seek your clarification as why calculation of capital employed is taken at opening balance of each period.
Thank you & regards
Eve
Hi
I am a bit confused so seek your clarification regarding EVA : as why calculation of capital employed is taken at opening balance of each period.
Thank you & regards
Eve
It is simply a matter of how the inventors of EVA designed capital employed. You often see EVA called EVATM. (The TM should be subscripted). TM means the approach is trade marked so you are supposed to follow what they say if you are doing EVA.
Hi
I am a bit confused with Capital employed? May I know why EVA has to use capital employed at opening balance of the year. What’s the logic behind. Meaning for example : given the closing CE 2016, when computing EVA, calculation of CE will take opening balance of 2016.
Please help to ask my enquiry.
Thank you & regards
Mei
Thank you so much Opentuition!!!
Dear Sir,
Great lecture but one point I am confused by based on what you said in the EVA adjustments section and other teaching provider notes I have read and that is around the treatment of non-cash expenses. You said that they are added back to Income Statement but didn’t mention any adjustment to Op. Capital Employed, this approach is consistent with what Kaplan teaches. However when you went through the simple example non-cash expenses for 2014 were added back to the capital employed figure for that year to get adjusted opening capital employed for 2015. Kaplan and other teaching providers and model exam answers don’t seem to make this adjustment to capital employed so am confused on correct treatment.
Thanks Mark
Please Ignore my question just found an example where they did add it back, typical Kaplan not being consistent and/or reviewing their answers before going to print.
Thanks Mark
No problems. Kaplan might not have been inconsistent. If non-cash expenses happen in the current year, then they have no effect on the opening capital employed.
hello sir,
i have a ques from the dec 2007 ques alpha delta gamma
as int he second example you said we should add back the non cash expense and the RnD cost of 2013 to reach to the ttal fig of capital employed of 446.
i tried to use the same logic to dec 2007 ques
gamma division part (b)
capital employed for year 2006 ( 279 +16 +45) = 340
capital employed for year 2007 (340+ 16+ 45+ 5+ 12) = 418
my answer for year 2007 is different from the suggested answer as i have added the $12 for non cash expense. why we will not add that back? as we have to compute capital employed opening balance?
is it because the closing bal of 2006 of 340 in FS (given in ques) is equal to the adjusted capital employed fig for 2006?
I have the same question about CE for year 2007.
Why non-cash expenses $12m that happen in the previous year have no effect on the 2007 opening capital employed. My calculations are the same as shreya’s:
capital employed for year 2007 (340+ 16+ 45+ 5+ 12) = 418
but this differs from what suggested answer is (340+ 16+ 45+ 5) = 406?
Any idea?
Got it, Thank you so much!!
I’m not sure which exmple you are looking at but at about Time 26.00 in the lecture I do add back R&D to the opening vapital employed for 2014. The project started in 2013 so there wasnothing to add back to the b/f figure for 2013.
Does that make sense?
Thank you for your reply, What I wanted to ask was about this video lecture and time 26 min only but my question is that why did we put current years R&D figures for NOPAT and we are looking for b/f figures in case of capital employed!!!!
Look at this example:
31/12/2015 CE = 5000; 12 months to 31/12/2015 R&D = 100
31/12/2014 CE = 4500; 12 months to 31/12/2014 R&D = 80 (first year of project)
31/12/2014 CE = 4250
NOPAT for both years would have that year’s R&D added back, 100 for 2015 and 80 for 2014.
CE for EVA of 2014 = 4250 (opening)
CE for EVA of 2015 = 4500 + 80 [ie the 80 that had been charged during 2014]
Dear Sir
Very Nice lecture but the only concern I have is while calculating capital employed you never added back R&D expense given for respective years but in NOPAT you did!!!
I am slightly confused about the logic or is it the approach we just have to follow???
Regards
Adesh