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Hi Cath.
An EVA question:
I have rewatched the EVA lecture but it did not help me answer the question…
196) Which of the following statements are true of Economic Value Added®? Select all that apply.
?1. It is based on historical figures that could be distorted.- True
? 2. Maximisation should create wealth for shareholders.- hhmm I would have picked true
?3. It encourages managers to focus on projects with large initial expenditure. Not sure I can make the link here.. I guess large initial expenditure is likely to be R&D or advertising.. which will be included in the calculation..
? It does not include non-capitalised goodwill, which may be an important value driver.
? It does not include a financing element.- Not sure about this point because of something I read in my BPP text bookThe text book under the EVA chapter mentions..
Cost that normally would be treated as an expensed but which are considered within an EVA calculation as “Investments building for the future” mare added back to NOPAT to derive a figure for economic profit. These costs are included instead as assets in the figure for net assets employed. Examples of these costs are goodwill, research and development costs etc.
The above paragraph seems to suggest that EVA includes goodwill… does the paragraph mean just capitalized goodwill?
Thanks
Abi
Hi,
The adjustment for items relating to goodwill involves adding back any amortisation or goodwill which is written off. This is because these adjustments are due to the accounting treatments Instead EVA wishes to reflect a true value of the goodwill which can be adjusted in value if some impairment has occurred.The technique requires all the intangible assets to be recognised and added back – so that includes R&D, goodwill and marketing.
If goodwill is mentioned as being written off, not-capitalised or amortised then the amounts written off need to be added back in the same way as accounting depreciation is added back to tangible assets.
Hope that helps.
Hi Cath.
Thanks.. Still a little confused by the point-
1. “It does not include non-capitalized goodwill, which may be an important value driver”
So are we saying that irrespective of whether goodwill is capitalized or not it should be added back to EVA because EVA wants to reflect the TRUE value of goodwill?
How about point 3:
3. EVA encourages managers to focus on projects with large initial expenditure.
Has this got something to do with R&D and the fact that these costs can be amortized/ capitalized and sent to the Balance sheet and not expensed in the early years of the project?
Thank you again Cath.
From Abi.
Hi – When calculating EVA there are potentially 160 adjustments that can be made. It is a common criticism that EVA is rather a new and unregulated method – so in real life there can be a lack of consistent rules regarding its calculation.
It’s also hard give a rule for sure without seeing actual facts regarding each adjustment.
I believe that any goodwill mentioned in the question should be added back if it is is related to creation of value and building future assets for the company.
In terms of over investing in high value projects – it depends on the composition/ nature of the high value projects. There is definitely no dis-incentive to spend on projects which involve R&D, advertising and staff training etc because these expenses can be added back to increase economic profit.
However, any part of the investment that increases the capital employed will cause a slightly bigger deduction (capital employed x Wacc %) when calculating final EVA figure. This is not likely to net off the effect of the increases in economic profit but will reduce the EVA surplus in some respect.So although EVA doesn’t provide a disincentive to investment in the same way as ROI can do – Im not sure that I would support the idea that the bigger spend is better.
Hope thats some help 🙂
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