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Related Topics
- Discounted and Free Cash-Flow Analyses
- ROA, RONA, ROI Techniques
- Shareholder Value Analysis
Description
Economic
Value-Added Analysis measures the amount of value a company
has created for its shareholders. It determines how much
profit a company has produced after it has covered the cost of
its capital. Whereas conventional accounting methods deduct
interest payments on debt, Economic Value-Added Analysis also
deducts the cost of equity?what shareholders would have earned
in price appreciation and dividends by investing in a
portfolio of companies with similar risk profiles. Economic
Value-Added Analysis thus offers a truer picture of the return
a company delivers to its shareholders and provides a
framework to assess options for increasing it. By making the
cost of capital visible, Economic Value-Added Analysis helps
companies identify whether they need to operate more
efficiently, to focus investment on projects that are in the
best interests of shareholders and to work to dispose of or
reduce investment in activities that generate low
returns.
Methodology
Economic
Value-Added Analysis consists of three primary analyses. A
manager should:
- Determine the net after-tax operating profit generated by a business.
- Estimate the return required by investors. This calculation requires two inputs. First, identify
the dollars invested in the firm. Then determine the cost of equity, or the return shareholders
could have expected in dividends and appreciation from investing in stocks about as risky as
the company?s.
- Determine the Economic Value-Added by subtracting the expected return to shareholders
from the profits created by the firm. (Firms with positive Economic Value-Added generate
value above and beyond the level expected or required by shareholders.)
Common Uses
- Assess the performance of the business. Since Economic Value-Added Analysis accounts for
the cost of capital used to invest in a business, it provides a clear understanding of value
creation or degradation over time within the company. This information also can be linked to
management compensation plans.
- Test the hypotheses behind business plans, by understanding the fundamental drivers of
value in the business. This provides a common framework to discuss the soundness of each
plan.
- Determine priorities to meet the business?s full potential. This analysis illustrates which
options have the greatest impact on value creation, relative to the investments and risks
associated with each option. With these options clearly understood and priorities set,
management has a foundation for developing a practical plan to implement change.
- Help companies enhance their ability to acquire capital, either by demonstrating that they
provide superior returns to investors or by identifying where they need to make
improvements.
Related Bain capabilities
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Selected References
Copeland, Tom, Tim Koller and Jack
Murrin. Valuation: Measuring and Managing the Value of
Companies, 2d ed. John Wiley & Sons, 1995.
Ehrbar, A. EVA: The Real Key to Creating
Wealth. John Wiley & Sons, 1998.
Grant, James
L. Foundations of Economic Value Added, 2d ed. John
Wiley & Sons, 2002.
Knight, James A. Value Based
Management: Developing a Systematic Approach to Creating
Shareholder Value. McGraw-Hill, October 1997.
Luehrman, Timothy A. ?What?s It Worth?: A General
Manager?s Guide to Valuation.? Harvard Business
Review, May/June 1997, pp. 132-142.
Rappaport,
Alfred. Creating Shareholder Value: A Guide for Managers
and Investors. Free Press, 1997.
Stern, Joel M.,
and John S. Shiely, with Irwin Ross. The EVA Challenge:
Implementing Value-Added Change in an Organization. John
Wiley & Sons, 2001.
Stewart, G. Bennett, III.
The Quest for Value
. Stern Stewart, 1993.
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