According to Stewart (1991) once investors are aware of a company's EVA, the information should impact on market value. This is best measured by the associated concept of market value added (MVA) based on the following equation, where V equals the current total market value of debt plus equity, and C equals the EVA term for total capital raised by the firm since its inception..

(2) MVA = V - C

The interpretation of MVA is simple. If EVA is positive then the difference between V and C is positive and the company has created wealth (or vice versa). Of course, MVA improvements or deterioration also depend on factors apart from EVA, many of which may be beyond management's control (such as a banking crisis). But these need not concern us here. The important point is that within a company's sphere of influence, EVA must be a fundamental driver of market value.

8.3. Profit and Cash Flow

Unlike the earlier cash driven analyses of NPV with which you are familiar, EVA is based on accounting profits using NOPAT. So, how can the two concepts be equivalent?

From a financing perspective, we know that NOPAT is calculated by de-leveraging earnings, which entails adding back interest on debt capital to establish total distributable profits. But what of the principal non-cash expense customarily added back to accounting profit to derive cash flow, namely depreciation.

Depreciation remains deducted from NOPAT because it is the only way that accounting profit recoups the cost of investment. Remember, net cash inflows include depreciation because the cost of investment (I) is subtracted from their present value (PV) to determine NPV using the following formula.

NPV = PV - I

Of course, there are other anomalies that must be stripped from accounting income to produce a "cash equivalent". But if we are to believe Stewart (op cit) once these adjustments are performed, lifetime profit will approximate to lifetime cash surplus because all the accounting conventions will unwind.

8.4. EVA and Periodic MVA

Like EVA, MVA is a residual concept that defines what is left over after the total book value of capital (C) has been deducted from its total market value (V). Recalling Equation (2):

(2) MVA = V - C

Note that unlike periodic EVA, however, MVA is a cumulative measure of lifetime value added.

To measure the change in value over a one-year period, an opening MVA must be deducted from a closing MVA, which also isolates the effect of any new capital issues (I). Thus, our equation of periodic MVA is represented by:

(3) A MVA = MVA t - (MVA (t-1) + I)

So, if a firm's market valuation rose from £20 million to £26 million but capital of £9 million was injected during the year; corporate value would have fallen by £3 million overall.

Activity 1

To illustrate the inter-relationship between EVA and MVA consider the following company data.

V

NOPAT

C

K

Opening MVA

£m

£m

£m

%

£m

200

20

100

10%

90

- Calculate periodic EVA and lifetime MVA.

- Establish whether periodic wealth been created or destroyed using MVA.

Calculations for periodic EVA and closing MVA are determined by Equations (1) and (2). EVA = NOPAT - (CK) = £20m - (£100m x 0.1) = £10m

MVA = V - C = £200m - £100m = £100m

Wealth has also been created without any new investment over the period. Using Equation (3)

A MVA = MVA t - ( MVA (t-1) + I ) = £100m - (£90m + 0) = £10m

Note also the perfect positive relationship between the creation of internal EVA and the external DMVA. Market value of £10m is added to the company because the monetary return on investment exceeds the cost of finance by £10m. Mathematically, Equations (1) and (3) are therefore equivalent

(4) EVA = A MVA

Found a mistake? Please highlight the word and press Shift + Enter