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Dear sir
In the article by shane Johnson, he says one of the problem with EVA is :
“The use of conventional depreciation methods means that there is no
guarantee that the measurement of EVA™ in the short-term will be
consistent with the measurement of EVA™ in the longer-term.”
What it means by this?It is because accounting depreciation does not really show the true cost of using an asset. For EVA it should be replaced by economic depreciation, but calculating this is not in the syllabus.
I understand when adding back interest to PAT to get adjusted profit, we must multiply (1-t), then what other non-cash expenses need to mutilply (1-t) and then add back, and what are those expenses that are no need to adjust for tax, and why? Thank you.
Regarding operating lease, why consider it as off balance sheet transaction, and therefore added back to adjusted capital? But no adjustment made for adjusted profit?
By the way, EVA = Adjusted profit – WACC x adjusted capitalFor EVA we want the ‘cash’ profit after tax, but before interest (because interest is taken account of in the WACC).
So it is only interest where tax needs taking into account. Even if other items are adjusted for to get a ‘cash’ profit, these adjustments will not affect the tax payable.
With regard to operating leases. They should be added to adjusted capital (the present value of them). Also the implied interest element of the lease payments should be added back to the adjusted profit. Shane Johnsom ignored this in his article – it was for P5 and was only meant to explain the basic idea. I don’t think at P4 he would expect you to deal with the implied interest – that and the valuing of the lease for the balance sheet is one of the most complicated/arguable parts of EVA.
Thanks for the definition of EVA (although I did know what it was already 🙂 !!)
Eg. Advertising exp, in P&L, deducted as an exp, then x (1-t) to arrive at PAT. For EVA, as it is an capEx, it should be added back the same amount deducted previously to PAT, ie net amount. Why isn’t there any tax effect, pls?
I have a question, the answer shows most of expenses (goodwill, advertising, R&D, etc) adjusted for (1-t), except depreciation. Don’t quite understand why depreciation is special, and any other special cases or not?
Thanks.Making adjustments to the profit figure will not effect the tax charge (which is a cash flow) which is why no adjustments are made to the tax. The only tax adjustment is that you add back the interest net of tax.
[P&L]
Turnover 546
COGS (369)
Depn (52)
Adv (10)
Net int (26)
= PBT 89
Tax (27)
= PAT 62Which method is correct to get adjusted profit for EVA, pls?
Method 1:
Turnover 546
COGS (369)
Depn (52)
= PBT 125
Tax30% (37.5)
= NOPAT 87.5Method 2:
PAT 62
+Adv 10
+Int 18.2 <- 26x0.7
= NOPAT 90.2Why different result, pls? Thank you.
The second method is correct.
(The only adjustment that should be made to the tax charge is because of the interest).The reason the result is different is because in your method 1 you have effectively adjusted also for the tax on Adv (10 x 30% = 3). The correct PAT in your Income Statement is 62.3, and if you had used that in your method 2 you would have arrived at NOPAT of 90.5 which is 3 different from method 1.
Method 2 is correct.“(b) Relationship between EVA and net present value (NPV)
If the EVAs for each year of an investment were summed over the entire life of the investment and then discounted, the result, in theory, should equal the NPV of the investment.”For investment appraisal, when all PV each year NCF summed over the entire life of the investment, we get NPV. So what is the difference bewteen EVA and PV, pls?
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