Economic Value Added

Economic Value Added (EVA) is important because it is used as an indicator of how profitable company projects are and it therefore serves as a reflection of management performance. The idea behind EVA is that businesses are only truly profitable when they create wealth for their shareholders, and the measure of this goes beyond calculating net income. Economic value added asserts that businesses should create returns at a rate above their cost of capital * The economic value calculation has many advantages. It succinctly summarizes how much and from where a company created wealth. It includes the balance sheet in the calculation and encourages managers to think about assets as well as expenses in their decisions. The EVA calculation depends heavily on invested capital, and it is therefore most applicable to asset-intensive companies that are generally stable. Thus, EVA is more useful for auto manufacturers, for example, than software companies or service impasses with a lot of intangible assets. Does the profit minimization reveal the wealth created by the firm? Profit minimization is not consistent with wealth minimization. It has some drawbacks and cannot be used for effective evaluation on the performance of the firm.

On the other hand, wealth minimization, which is also known as the net present worth of a firm can be used to evaluate the performance of the firm. Wealth minimization is seen as more comprehensive and superior than profit minimization. Profit Economic Value Added By Tidewater Again, the profit minimization objective does not factor in time value of money incinerations. Therefore wealth minimization is superior because it is a long term objective and considers the time value of money by discounting cash flows to the present time.

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!

order now

Additionally, wealth minimization considers uncertainty by discounting at the required rate of return and considering the other stakeholders of the firm. It is not clear on when the profit is counted as profit – whether this should be before or after tax. Another uncertainty involves the long-term or short-term profit. Short term profit can be foregone by avoiding some expenditure but in the long run, these expenditures have to be paid for. Therefore long-term profit has to be considered, and not short term profit. Wealth minimization shows the present value of benefits minus the cost of the investment.

Profit minimization does not factor in risk. Different projects have different degrees of risk of future earnings. A project with fluctuating earnings is not the same as one with certainty earnings. By not looking at the risk factor of projects, profit minimization cannot be used for the operational objective of the firm. Risk is considered in wealth minimization as the discounted rate used to determine the present value of future cash flows factors in the risk. Lastly, profit minimization does not factor in the time value of money. A dollar spent today is not equivalent to the same dollar spent tomorrow.

Cash drawn from a project in different years is considered the same, which is not realistic. Wealth minimization considers the time value of money as the cash drawn from a project in different years are not the same. The discounted rate that determines the present value of future cash flows shows both risk and time. Hence we can conclude that profit minimization does not reveal the wealth created by the firm. Discuss any five Indian firms that have adopted performance measures like EVA. ) Inflows Source: http://www. Inflows. Com/ The statement shows the details value addition of last five years by the company.

Highest income generation source is due to production activities which is carrying 34% to 40%. Likewise company is mostly devoted to its employees and around 40% of value is paid to them. It is paying 20% of income in tax. 11% of earning is paid to shareholder as dividend. Still company is able to retain 2. 5 times of dividend, means enough fund for growth of its business. 2) BELLE Source: Annual reports of BELLE Table -1 shows a picture of Economic value Added and Cost of Equity Capital of BELLE Ltd. In the beginning EVA is noted only RSI 366 (Cry) which increased by 229. 73 percentage compare to previous year.

The Average EVA noted is 1735. 88(Cry), which holders ,with the help of Arithmetic Mean it is found that EVA of Company will be increased by 66. 29%, where focus has also given in Cost of Equity Capital of company and Mean of Cost of equity capital noted 12. 9 which decreased then two consecutive years. 3) NIT The New Delhi-based software training and development major NIT linked the performance incentive of its employees to the incremental contribution they make to he company’s performance according to the ‘economic value added concept’ developed by the US based Stern Stewart and Company.